The Reserve Bank of India's unpredictability on when it could restrict lenders from the non-deliverable forwards (NDF) market has led banks to reconsider their trading approach, hampering volumes in that segment, bankers said.
The RBI first opened the NDF market to Indian banks in June 2020, and to resident Indians this June, to deepen participation.
Click here to connect with us on WhatsApp
However, on two occasions in the past year when the rupee was under strain, it has informally restricted banks from building fresh arbitrage positions as that dilutes the impact of the central bank's intervention in the over-the-counter (OTC) market, bankers said.
The effect is evident in banks' monthly NDF trading volumes, which declined by 33% month-on-month to $72.1 billion in September, CCIL data shows. That is similar to the drop in October 2022 after the previous restriction.
The hesitancy among banks is only growing.
"Unless there is stability in the RBI's approach, there will not be interest in building up (proprietary) NDF positions and the focus will be on (relatively small) customer flows," a treasury executive at a private sector bank said.
More From This Section
Already banks are reducing the size of their books -- from about $25 billion last year to under $1 billion now, in the case of a large public sector bank.
"We are unlikely to build back the book to the same or larger size given the risks," a dealer at the bank said, requesting anonymity as they are not authorised to speak to the media.
The dealer is based out of GIFT City, an international financial services centre (IFSC) from where banks are allowed to build their positions in the NDF market.
A large part of a bank's NDF book is related to arbitrage positions, which are attractive during market uncertainty as then, the USD/INR NDF trades at a premium to the OTC rate.
The RBI's halts lead to volatility in NDF forward points, which has mark-to-market implications for existing arbitrage positions, the head of proprietary trading at a private sector bank explained.
"To avoid this, we have taken a decision to not do NDF altogether for our own books."
While RBI's informal restrictions are for new positions, he said, banks may just decide to unwind existing positions as well.
(Only the headline and picture of this report may have been reworked by the Business Standard staff; the rest of the content is auto-generated from a syndicated feed.)