New Delhi: Banks have urged the Reserve Bank of India (RBI) to reconsider its newly announced requirement for a 20% cash deposit on foreign exchange (FX) derivatives used to hedge current-account exposures. Lenders have approached the central bank through a forex industry body, seeking the withdrawal of the deposit mandate and the removal of the $2 million threshold above which the requirement applies, according to people familiar with the discussions.
The request follows a series of measures announced by the RBI on Saturday to curb corporate demand for forward dollars and ease pressure on the Indian rupee. The currency has been under pressure due to elevated oil prices and capital outflows.
The rupee strengthened by around 1% on Monday following the RBI’s regulatory measures, which also included steps to redirect oil companies’ dollar demand away from the spot market.
Banks Propose Alternative Charge Instead of 20% Deposit
Lenders have proposed replacing the mandatory 20% cash deposit with a flat charge on companies using forward dollar purchases or other derivatives to hedge their current-account exposures.
According to bankers, the deposit requirement could increase hedging costs for companies while locking up rupee liquidity in banks’ treasury operations.
Banks have suggested that a direct charge could achieve the regulator’s objective without creating the same liquidity constraints. Their key arguments include:
- Higher hedging costs: The 20% deposit requirement could make it more expensive for companies to hedge foreign exchange risks.
- Liquidity constraints: The mandate could tie up rupee funds in banks’ treasury operations.
- Alternative approach: A flat charge on hedging transactions could discourage excessive forward-dollar demand without requiring the same cash deposit.
A banker who attended a meeting of the Foreign Exchange Dealers’ Association of India (FEDAI) on Sunday said banks would pass the additional cost on to their clients.
The banker suggested that imposing a higher charge directly, potentially expressed in paisa terms, would reduce friction compared with requiring banks to maintain a cash reserve equivalent to 20% of the relevant exposure.
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RBI Rule Could Absorb Significant Rupee Liquidity
The banking industry has raised concerns about the potential liquidity impact of the new requirement, particularly if it affects a substantial volume of corporate hedging transactions.
Citi economists have estimated that approximately ₹60,000 crore to ₹70,000 crore ($6.27 billion to $7.31 billion) in liquidity could be absorbed, even if importer hedging activity declines considerably.
Banks have highlighted the following concerns:
- A substantial amount of rupee liquidity could be tied up under the deposit requirement.
- Reduced importer hedging may not fully prevent the potential liquidity impact.
- Replacing the deposit mandate with a flat charge could help limit liquidity constraints while increasing the cost of hedging transactions.
Lenders Seek Removal of $2 Million Threshold
Banks have also asked the RBI to remove the $2 million threshold above which the 20% deposit requirement applies.
Lenders warn that the threshold could encourage companies to divide large hedging transactions into several smaller deals to remain below the prescribed limit.
Bankers have identified several challenges with the existing threshold:
- Transaction splitting: Companies could break larger hedges into smaller transactions below $2 million.
- Monitoring difficulties: Banks may find it challenging to identify and track multiple smaller transactions.
- Limited scrutiny: Bankers say they may not be able to question clients booking several smaller deals.
Lenders believe removing the threshold would help avoid incentives for splitting transactions and simplify the implementation of the rules.
Banks Seek Clarity on Foreign Loan Interest Payments
In addition to requesting changes to the deposit requirement, lenders have sought clarification on whether the rule applies to hedging interest payments on foreign-currency loans.
The existing rules do not cover hedging transactions related to principal repayments on overseas loans. However, banks want the RBI to clarify whether hedges against interest payments on such loans will also be exempt.
The distinction matters for companies managing foreign-currency borrowing costs and exchange-rate risks. Banks are seeking clear guidance on:
- Whether hedging interest payments on overseas loans falls within the 20% deposit requirement.
- Whether the exemption for principal repayment hedges also extends to interest payment hedges.
The RBI had not immediately responded to an email seeking comment on the lenders’ requests.
About the Reserve Bank of India (RBI)
The Reserve Bank of India is India’s central bank and monetary authority. It regulates the country’s banking and financial system, manages monetary policy, oversees foreign exchange operations and works to maintain financial stability. The RBI also implements measures to address volatility in the foreign exchange market and support orderly currency movements.
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