RBI sets conditions for derivative deals by banks

To ensure that India Inc doesn't get carried away by the lure of making a fast buck, the Reserve Bank of India has asked banks to obtain board resolutions from companies on their risk management policy before offering derivatives products.

In general, banks should not undertake derivative transactions with, or sell structured products to, users who do not have properly documented policies regarding management of risks that include, among other things, guidelines on risk identification, management and control, the RBI said.

The modification in RBI's guidelines on derivatives comes in the backdrop of corporates dragging banks to the courts about two years back when their derivative bets went wrong due to adverse currency movements.

The objectives

The objective of the RBI's guidelines is prudential in nature: to protect the banks against the credit, reputation and litigation risks that may arise from a user's inadequate understanding of the nature and risks of the derivatives transaction.

The board-approved risk management policy of corporates, as envisaged by the RBI, should have guidelines and procedures to be followed with respect to revaluation and monitoring of positions.

Further, the policy should contain names and designation of officials authorised to undertake transactions and limits assigned to them; and a requirement that the assignment of limits to an official would be specific.

The policy should also deal with the accounting policy and disclosure norms to be followed in respect of derivative transactions; a requirement to disclose the MTM valuations appropriately; mechanism regarding reporting of data to the Board, including financial position of transaction, and so on.

Responsible behaviour

“Banks are well-regulated by the Reserve Bank of India. So, the modified guidelines issued by the RBI on derivatives are a way of ensuring responsible market behaviour by corporates through banks,” said Mr N.S. Venkatesh, Chief General Manager & Head – Treasury, IDBI Bank.

Banks should not undertake derivative transaction with users till they provide a Board or equivalent forum resolution stating that they have in place a Board-approved Risk Management Policy, the RBI said.

Emphasising that the responsibility of ‘Customer Appropriateness and Suitability' review is on banks, the RBI said a bank's compliance officer should submit a monthly report to the Board of Directors of the bank certifying that all the guidelines have been followed for all derivative transactions undertaken by the bank.