RBI clarifies banks must maintain 20% FERR over and above CRR balance

RBI says banks must park a 20% forex risk reserve in CRR accounts over and above mandatory balances, as the new rules raise hedging costs and push up forward premiums

Reserve Bank of India

Anjali Kumari Mumbai

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The Reserve Bank of India (RBI) on Thursday clarified that banks must maintain the 20 per cent foreign exchange risk reserve (FERR) in their cash reserve ratio (CRR) accounts, over and above the mandatory CRR balance, and keep records for the central bank to verify compliance during audits.

The clarification, issued through frequently asked questions (FAQs), formalises an arrangement banks had worked out among themselves on Monday evening, when the new rules came into effect. The requirement is adding to hedging costs and pushing up forex forward premiums.

“The only clarity that was probably missing was where to place the FERR money. All banks took a decision on Monday evening that we would keep it in our CRR balance. The RBI has now clarified that this is the account where the money has to be maintained, and it will check during audits that we have maintained 20 per cent in our CRR account,” said the treasury head at a private bank.

The FERR is equivalent to 20 per cent of the rupee value of the notional amount of eligible foreign exchange derivative contracts. It applies to specified rupee-linked contracts where users buy foreign currency to hedge current account transactions and the notional value exceeds $2 million. Banks must also maintain the reserve for eligible contracts undertaken to hedge currency risks on their own assets and liabilities.

Forward premiums have risen sharply as banks and customers unwind positions and adjust to the new rules. Market participants expect the rupee to weaken over the longer term despite its recent recovery, prompting importers to use current levels to lock in forward dollar purchases.

Banks are advising some customers to book shorter-dated forward contracts of two to three months rather than hedge their entire exposure for longer periods. This is in the hope that market conditions will stabilise and the restrictions may be reviewed in the coming months, market participants said. However, there is no certainty that the RBI will withdraw the measures.

Under the new rules, transactions undertaken from Monday onwards are subject to the revised guidelines, whether they are fresh contracts or rollovers. The RBI has also restricted the rebooking of cancelled foreign exchange derivative contracts.

The reserve requirement is adding to hedging costs because the funds parked with the RBI do not earn interest. Banks must maintain the reserve daily for each eligible transaction and keep it in place until a day after the derivative contract terminates.

Banks that had raised foreign currency non-resident (FCNR(B)) deposits were also assessing how best to hedge the interest component of their FCNR(B) deposit dollar exposure. Some had hedged their exposure through forwards and other derivative transactions, while others had not fully hedged it. Banks could choose to retain some unhedged exposure if they expected the rupee to remain around current levels, though their decisions would depend on their outlook for the currency.