RBI asks banks to set aside capital, provisions for unhedged FX exposure

RBI asks banks to set aside capital, provisions for unhedged FX exposure: The Reserve Bank of India (RBI) updated its guidelines for banks on additional capital and provisioning needs in regard to unhedged foreign currency exposures in response to the weakening of the rupee against the US dollar. The new rules will come into effect from January 1, 2023.

Updated guidelines

• The RBI stated that banks must determine all entities’ foreign currency exposure at least annually, and that the exposures must be computed using relevant accounting standards. Banks must consider goods maturing or having cash flows over the following five years for this purpose.
• Statutory auditors must audit and certify information on unhedged foreign currency exposures at least once a year.
• Banks will have to estimate the possible loss from unhedged exposure using the highest yearly fluctuation in US dollar/rupee exchange rates over the last ten years to arrive at provisioning and capital needs, according to the RBI. Unhedged exposures in currencies other than the US dollar must be translated into US dollars at market prices.
• The central bank advised calculating the ratio of potential loss over the previous four quarters to determine the exposure to unfavourable currency rate fluctuations. Banks may use data from the four prior quarters if they are unable to get such information from listed firms for the most recent quarter.

What do you mean by FX Exposure?

The risk that a business takes while conducting transactions in foreign currencies is referred to as forex exposure. In order to implement a determined risk management strategy, it is crucial for businesses intending to deal in other currencies to first determine their risk exposure. For instance, if an Indian company competes against Chinese-imported goods, and the Chinese yuan per Indian rupee declines, the importers benefit from a lower cost advantage over the Indian company. This demonstrates that enterprises with no direct link to the forex are affected by currency fluctuations.

What is Rupee Depreciation?

The rupee has declined by roughly 10% against the US dollar so far in 2022, prompting increased scrutiny of enterprises’ unhedged exposure through foreign currency borrowings. Depreciation of the rupee refers to a decline in the value of the rupee relative to the dollar. It means that the rupee is now weaker than it was previously. Rupee Depreciation in relation to the dollar, means it now costs more rupees to buy one dollar than it did in the past. Earlier, 1 USD= Rs 77, now it is Rs 82.