FOREIGN EXCHANGE DERIVATIVES

The fluctuations in the foreign exchange market in the recent months have resulted into large foreign exchanges losses. The foreign exchange exposure is becoming a matter of concern.RBI has permitted forward contract, options, swap and similar other structures for hedging foreign exchange risk. Recently there have been serious complaints from the banks’ customers that banks have written options on their behalf without properly apprising them of the risk involved resulting into losses of several hundred crores to business community. Writing of forex options by the banks customers are prohibited by RBI. But banking industry took the liberty in view of certain loopholes in the language of RBI Circular permitting banks to offer cost reduction structures. This is required to be appropriately clarified and corrected by RBI on an urgent basis. A significant lesson has been learnt by financial experts that buying simple vanilla options is most advantageous. RBI and SEBI have recently permitted currency future to be traded on stock exchanges. This is an excellent idea; however, the currency future should be restricted only to persons having underlying currency risk for hedging and not for the purpose of speculation.

The foreign currency future dealings by speculators could be very dangerous and is against the spirit of RBI policy of permitting hedging in foreign currency on the basis of underlying or expected exposures only. The government of India may reconsider the matter in consultation with SEBI and RBI to ensure that large losses are not incurred by small uninformed investors in the currency futures
market. It may also be worthwhile to consider permitting vanilla options contract through transparent
mechanism of the stock exchanges, wherein the authorized dealer category-1 (Banks) may be permitted to write the option and the user of the banking system can buy the option. Risk management for banks also needs detailed regulatory advice.