Indian Bank expects the Reserve Bank of India’s requirement to set aside 20% of the value of certain rupee-linked currency derivatives to raise funding costs, despite no immediate hit to forex income.
Indian Bank expects the Reserve Bank of India’s new foreign exchange risk reserve rule to put pressure on profitability, even though it should not directly cut forex income, a senior executive said on Friday. Managing director and chief executive Binod Kumar said the requirement to set aside 20% of the notional value of certain currency derivative contracts would lock up funds without generating interest, increasing costs for lenders active in the foreign exchange market. The Reserve Bank introduced the measure on 10 October amid sharp rupee weakness, and later clarified that it applies only to specific rupee-linked contracts used to hedge current account transactions, with a threshold of more than $2 million.
The central bank’s detailed FAQs say the reserve must equal 20% of the rupee value of each qualifying contract and that banks should guard against attempts to split transactions to sidestep the limit. In one example cited by the Reserve Bank, a $10 million contract struck at Rs 95 to the dollar would require a reserve of Rs 19 crore. Industry reports have also said the amount must be held in cash reserve ratio accounts above the normal CRR balance, adding to hedging costs and forward premiums.
Indian Bank’s comments came after a strong quarter for its treasury business. According to the bank’s investor presentation, forex income jumped 108.12% year-on-year to Rs 311 crore in July-September, helped by heightened currency volatility, while the increase on a sequential basis was 10.6%. Kumar said that volatility, rather than any structural shift in business, drove the gain and that the new reserve rule should not affect forex income in the next few quarters.
The bank also trimmed lending to the petroleum and coal products segment by 32.97% from a year earlier to Rs 6,997 crore, with Kumar saying the move reflected pricing discipline rather than sector stress. He said some public sector borrowers were seeking rates of about 6.10%, which the bank was unwilling to offer, and that the sector’s share of gross advances fell to 1.06% from 1.82% a year earlier. On deposit pricing, Kumar said the transmission of higher rates would likely start towards the end of the third quarter, once excess liquidity eases, though he expects only a modest initial rise in the weighted average cost of deposits.
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