The Hindu Business Line : Banks can sell derivative products

Mumbai April 20 The Reserve Bank of India has permitted commercial banks (excluding regional rural banks) and primary dealers to sell derivative products. According to the revised guidelines on derivatives by the RBI, banks and primary dealers should develop sufficient understanding and expertise about derivative products in terms of staff and systems to undertake derivative business as market makers. RBI has identified business entities with identified underlying risk exposure as users.

The RBI has allowed banks and primary dealers to trade in rupee interest rate derivatives, which includes Interest Rate Swap (IRS), Forward Rate Agreement (FRAs) and Interest Rate Futures, Foreign Currency derivatives and Foreign Currency Forward, which includes Currency Swap and Currency Option.

The RBI defines derivative as an instrument, settled at a future date, whose value is derived from a change in interest rate, foreign exchange rate, credit rating or credit index, price of securities (also called "underlying"), or a combination of more than one of them.

"Eligible entities can undertake different types of plain vanilla FRAs or IRS. Swaps having explicit or implicit option features such as caps, floors or collars are not permitted," said the notification.

Banks may undertake interest rate futures transactions to hedge the interest rate risk on their investments in government securities in AFS and HFT portfolios.

All permitted derivative transactions, including roll over, restructuring and novation shall be contracted only at prevailing market rates. The notification further explains, that all risks arising from derivatives exposures should be analysed and documented, both at transaction and portfolio level.

"The management of derivatives activities should be an integral part of the overall risk management policy and mechanism. It is desirable that the board of directors and senior management understand the risks inherent in the derivatives activities being undertaken," the statement added.

Guidelines on foreign exchange derivatives will be issued separately, said the notification.

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