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Skating on thin ice

How bad forex derivatives losses get will depend on the rates.

     Print Edition: May 18, 2008

Last fortnight, when Axis Bank came out with its list of foreign exchange derivatives transactions, there was a sigh of relief. The bank disclosed a contingent provision of Rs 72 crore towards forex derivatives losses and a mark-to-market loss of Rs 20 crore on its creditlinked notes exposure. Ending March 2008, clients of Axis were looking at a mark-to-market loss of Rs 672 crore from 188 forex transactions.

Axis Bank’s Nayak: Some relief
Axis Bank’s Nayak
This was by far the most transparent low-down on a problem that seems to shrink and swell by turns as the forex market moves. As global markets respond to the credit crisis, India it seems is getting a flavour of being ever more linked to these markets. Estimates of the total losses related to forex derivatives transactions range from Rs 5,000 crore to four times as much if not more. Around 18-20 suits have already been filed by companies against banks repudiating some of these losses.

What lies at the core of the issue is that some of these contracts were probably against the exchange contract laws, and if that’s the case then they will not be able to stand legal scrutiny. Hence, banks may not be able to enforce such contracts. Were the banks then mis-selling? “During 2007, several banks, though not all, have sold products which were neither appropriate nor necessary,” says Berjis Desai, Managing Partner of law firm JSA Associates. “There definitely has been some very aggressive marketing.”

While the going was good it mattered little as both the banks and companies made money. But now in the past few months as the markets took a downturn, companies were badly hit. Especially in case of smaller companies where losses turned out to be gargantuan compared to their net worth. Even though some of these contracts may be on the border of gray legal areas, wilful non-payment clearly is not an option for companies. It disturbs existing banking relationships and also makes future transactions tough.

Naturally then legal recourse is one option that companies such as Rajshree Sugars and Nahar Industries and others have adopted. Another equally viable option is to opt for an out-ofcourt settlement with both parties sharing the losses. However, much will depend on how the markets fare. As the dollar appreciated versus the yen last fortnight it seemed time alone will mitigate the risks. And hence, banking sector observers believe that many affected companies are probably waiting to see which way the tide turns before taking decisive action. They may also be waiting to see the outcome of the existing court actions. BT contacted a few companies most of which declined to comment on the issue.

This obviously raises the spectre of higher non-performing loans for the banks in the medium term should the currency movements again turn adverse. Significantly, banks have made differing levels of disclosures towards these losses. Though the Reserve Bank of India does not believe that the issue threatens to be a systemic concern just yet, it is examining the representations made by some companies. RBI Governor, Y. V. Reddy recently said, “RBI has given some time back comprehensive guidelines on the derivatives, and as long as they are followed by the banks in letter and in spirit, there should be no scope for disputes.”

The problem, of course, is what happens if the guidelines have been flouted?

Shalini S. Dagar

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