The Reserve Bank of India (RBI) on Thursday said that banks should encourage the hedging of commodity price risk by large agricultural borrowers because of volatile commodity prices.

It is a move to promote commodity derivatives market with involvement of banks, as now it will be regulated by SEBI.

“Banks provide a number of credit facilities to customers engaged in activities related to agriculture. Volatility in agricultural commodity prices may negatively impact such borrowers and the banks. Hence, hedging of agri-commodity price risk will be beneficial to both the borrowers and the banks,” RBI said in a release.

Borrowers who have taken loan for processing certain things can buy raw material or the commodities from futures exchange to keep raw material cost in check if they feel prices may go up in future or sell processed commodities on futures platform to ensure realisations are ensured if they see prices falling in future.

The central bank said that banks must encourage large agricultural borrowers such as agricultural commodity processors, traders, millers and aggregators to hedge their commodity price risk by using agri-commodity derivative products available on recognised exchanges in India.

At present, hedging tools including derivatives are available in the Indian market, but these are not being used extensively due to lack of awareness of the products or their inherent complexity, RBI said adding that banks may “educate their customers about the suitability and appropriateness of using these products for hedging specific exposures so that these customers can take an informed decision, lessening the scope for mis-selling of these derivatives”.

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