RBI: Expands risk reserve requirement to banks’ own hedges

The Reserve Bank of India expanded its foreign exchange risk reserve requirement on 12 October to cover eligible rupee-linked derivatives that authorised banks use to hedge their own assets and liabilities, according to Moneycontrol. The requirement locks up cash equal to 20 per cent of an eligible contract’s rupee value. Separately, BusinessLine reported that the RBI restricted specified banks and dealers to offering non-deliverable rupee derivatives to non-resident clients only for hedging.

The changes affect both the cost of managing currency risk and the purposes for which overseas clients can obtain certain rupee contracts. They do not amount to a reported ban on all currency hedging. The reserve measure ties up banks’ cash, while the non-deliverable derivatives restriction separates protection against an underlying currency exposure from trading solely on exchange-rate expectations.

The reports attribute the measures to efforts to support the rupee amid high oil prices and capital outflows. However, the supplied accounts of the October directions do not state a year. Their dates are therefore reported here without assigning one.

What the expanded reserve requires banks to hold

According to ETCFO’s report on the expanded requirement, the reserve applies to rupee currency contracts in which an authorised dealer buys foreign currency against the rupee, including contracts hedging the dealer’s own assets and liabilities. An authorised dealer is an institution permitted to conduct foreign exchange business.

The report says banks must deposit cash with the RBI daily and retain it until the contract ends. The amount is 20 per cent of the rupee equivalent of the contract’s notional amount. Notional amount means the reference value used to calculate the contract’s obligations, rather than its current profit or loss.

This is a cash-holding requirement, not a reported charge equal to that percentage. Its funding cost arises because the bank cannot deploy the money elsewhere while it remains deposited. The supplied reports do not establish whether the reserve earns interest.

The earlier measure was narrower. Moneycontrol says the RBI’s 10 October measures introduced the reserve for eligible client derivative contracts exceeding USD 2 million, where users buy foreign currency against the rupee to hedge current-account transactions. These include payments associated with trade and services, as distinct from transactions involving investments or borrowing principal.

The subsequent extension brings banks’ own currency-risk management within the reported scope. But the original directions are needed to establish precisely how thresholds, exclusions and transition arrangements apply across client contracts and banks’ own hedges.

The term also needs separating from India’s national foreign exchange reserves. Those are external assets held by the central bank, the subject of Digital Pradesh’s earlier coverage of India’s reserve adequacy against imports and external debt. The new risk reserve described in these reports is cash that banks must place with the RBI against eligible derivatives.

NDF access is restricted by purpose

A currency derivative takes its value from an exchange rate. Hedging uses such a contract to reduce an existing or expected currency risk; speculation takes a position to profit from a price movement.

A non-deliverable forward, or NDF, settles the difference between an agreed exchange rate and a reference rate at maturity without exchanging the underlying currencies. A study published in the Bank for International Settlements Quarterly Review in March 2014 explains that this produces a currency-linked payoff through a cash settlement, typically in US dollars.

That structure allows a user to protect against movements in a currency without taking delivery of it. The same structure can also support a speculative position. The instrument itself does not determine the purpose.

According to BusinessLine, banks with units in India’s International Financial Services Centre and certain primary dealers previously could offer non-deliverable rupee derivatives to non-residents for any purpose. They may now offer them only for hedging. An International Financial Services Centre is a designated jurisdiction for international financial business; primary dealers are institutions specialising in government securities markets.

The historical BIS study helps explain why regulators watch this market. Its authors found that offshore NDF pricing could lead domestic forward pricing during periods of strain. That is historical research, not evidence of the current size or influence of rupee NDF trading.

There is a material discrepancy in the supplied reporting. An Economic Times summary describes banks as no longer being able to offer rupee NDFs to clients. BusinessLine and ETCFO instead describe a hedging-only restriction for specified providers serving non-residents. Without the underlying directions and dated publication records, it is not possible to establish whether these accounts concern different measures or different scopes.

Importers face funding costs and tighter documentation

Importers with foreign-currency bills face the risk that a weaker rupee will increase their payment costs. A forward contract can fix the exchange rate for a future transaction. Exporters receiving foreign currency face a different exposure: rupee appreciation can reduce the domestic value of their receipts.

An ICICI Bank report, described in an ANI account carried by ETCFO on 13 October, said importers had been actively hedging while exporters had held back. The bank expected the measures to raise importers’ hedging costs and reduce excessive dollar demand. Those are the bank’s assessments, not demonstrated outcomes.

The package also changes how contracts can be managed. Moneycontrol reported that the RBI barred rebooking cancelled rupee-linked derivative contracts while allowing rollovers at maturity. Rebooking means entering a replacement contract after cancellation; a rollover extends protection when an existing contract matures.

The same report says the threshold for derivative positions without establishing the underlying exposure fell to USD 5 million from USD 100 million across authorised dealers and exchange-traded rupee derivatives. ETCFO’s account of ICICI Bank’s analysis also describes additional documentation intended to prevent the same exposure being hedged repeatedly.

These measures address different parts of trading activity: the reserve affects funding, documentation establishes the underlying risk, and rebooking restrictions limit how cancelled positions can be replaced.

Banks seek a charge instead of blocked cash

Business Standard, citing unnamed people familiar with discussions, reported that banks proposed replacing the cash deposit with a flat charge. Their argument was that a charge could make hedging more expensive without tying up liquidity in treasury operations.

The report also said lenders sought removal of the USD 2 million threshold, warning that companies could split hedges into smaller transactions. That is a concern attributed to bankers, not evidence that companies had done so. The RBI had not responded to the publication’s request for comment.

BusinessLine reported a rupee rise of about 1 per cent on the Monday following the weekend measures. The package included a special window supplying dollars to state-run oil refiners. That market movement does not isolate the effect of either the reserve requirement or the NDF restriction.

Foreign-currency deposit interest remains unresolved

A specific uncertainty concerns Foreign Currency Non-Resident (Bank), or FCNR(B), deposits: foreign-currency term deposits accepted from eligible non-residents.

The RBI’s supplied swap-facility FAQ, referring to its circular dated 8 June 2026, says the central bank’s swap covers deposit principal but not interest. A foreign exchange swap exchanges currencies with an agreement to reverse the exchange later.

That distinction leaves banks with a separate currency exposure on interest payments. Moneycontrol reported that lenders were seeking clarification on whether hedges for those payments attract the expanded reserve. Banks also wanted clarity on calculating and recovering the funding cost.

This article is based on the supplied reports and document extracts; live research was not available. The original October directions, their circular numbers, full effective-date provisions and any subsequent clarification could not be verified. Several reports may also share syndicated reporting and cannot be treated as independent corroboration. The supplied material does not settle whether FCNR(B) interest hedges are covered, or how banks must price the resulting cost.