One department of the RBI says there is no forex exposure to be hedged, another penalises companies for not doing so.
It may not be unusual in an evolving financial system to find different regulatory agencies, at times, getting into each other’s way.
For instance, ambiguity on jurisdiction over specific financial products recently caused a controversy in India. The differing approach that the SEBI and IRDA adopted over who should regulate equity-marked linked insurance products is a case in point.
Since these were two different regulators, the different approaches adopted by them was understandable.
However, more difficult to understand, even in an evolving financial system, are situations where different departments of a single regulator adopt different approaches on a particular policy issue. Such internal regulatory fracture results only in confusion and indecision in the market place. To add to the woes of the market, there are explicit penalties.
Two recent policy issues — falling within the jurisdictional domain of the Reserve Bank of India — highlight this fractured regulatory approach.
One department of the RBI has proposed that non-bank finance companies (NBFCs) progressively reduce the period for classifying loans into the non-performing category (NPA). From the present 180/360 days, the period is to be brought down to 120 days and then 90 days. That will bring in regulatory parity with the banking sector, the RBI says.But is a narrow focus on reducing perceived “regulatory arbitrage” blurring other policy objectives? One wonders if this is an appropriate time for making the borrowing environment even tougher for those “financially excluded” segments catered to by the NBFC sector. As it is, the economy is quite weak and lenders (NBFCs included) will be circumspect in expanding their loan book.
Tightening the asset classification norms would only make them more circumspect — unless, of course, the RBI feels that the credit purveyed by the NBFC sector is so large that it endangers its “inflation objective” itself!
Tactically, the proposed move goes against even the RBI’s own preference/global trend towards counter-cyclical regulations.
Indeed, a key feature of global financial regulation — after the crisis of 2007/2008 — is counter-cyclical policy, that is, policies that do not accentuate prevailing economic trends.
The focus is particularly on small business lending. The UK, for instance, is going to great lengths to promote increased lending to the SME sector. The Bank of England has not stopped with framing counter-cyclical policy.
It is even directly in the fray, providing direct funding support to financial institutions that increase SME lending.
In another draft guideline, the RBI has advised banks to increase the provisioning and maintain higher capital on corporate loans, where the corporate has large un-hedged FX exposures.
In fact, the RBI itself says that despite its repeated warnings “the extent of un-hedged foreign currency exposures of the corporate sector continues to be significant and this increases the probability of credit default in an environment of high currency volatility”.
Here seems to be another example of a fractured regulatory approach. The resulting penalty is paid by the corporate borrower in terms of higher credit costs.
Of course, one has to be thankful to the RBI for at least saying that we are living in a world of high currency volatility. For, it has always pointed out that it manages the local FX market closely and irons out excessive volatility!
Since volatility can be measured, one hopes the RBI will also lay down what is excessive and what is not.
For a start, that ambiguity about what constitutes excessive volatility in the eyes of the RBI is the foundation for the corporate sector’s travails on the FX front.
More importantly, “excessive” curbs on the hedging parameters — in terms of quantum, tenor and instruments — also severely limit the actual hedging activity of the corporate sector, through the bank-driven over-the-counter (OTC) market. That is, regulatory restrictions severely curtail hedging activity in the OTC market (bilateral market or dealings between a corporate and its banker).
And, these restrictions are placed by another department of the RBI.
(The non-OTC or exchange-traded market in India is gaining ground in terms of hedging tenors, liquidity and ease of trading. But, most critically, corporate awareness about this segment has to increase exponentially for it to be an effective hedging platform).
For instance, the RBI significantly limits the extent of hedging which even importers with a regular track record can carry out.
Even they have to produce documentary evidence of their exposures — which invariably will go out into many forward months.
Now, how can an importer line up documentary evidence of an exposure — which exists even presently based on his operational track record — but will be formalised with his supplier only as we go into the forward months?
For instance, it is highly likely that I will make an import payment in nine months’ time, but I do not have the documentary evidence to prove that right now.
Could I not hedge my “probable” exposure right now?
(There are other restrictions too for even importers who can produce the documentary evidence!).
If such an importer is not permitted by the regulator himself to hedge his “probable” exposures, then how can the regulator complain that the level of un-hedged exposures in the corporate sector is high — and strangely, go on to penalise the exposed corporate with higher credit costs also!
Effectively, one department of RBI says there is no exposure to be hedged. Another department penalises the corporate for not hedging the exposure!
The author is a Chennai-based financial consultant.