RBI tightens rules for rupee-linked forex derivatives, adds $5 million exposure cap and risk reserve

The Reserve Bank of India (RBI) on Oct 10 announced stricter regulations for foreign exchange derivatives, restricting the rebooking of cancelled rupee-linked contracts and lowering transaction limits for certain positions taken without establishing underlying exposure.The central bank said the measures were intended to maintain orderly functioning of the foreign exchange market amid changing market conditions.The revised framework also introduces additional documentation requirements and a new reserve obligation for specified derivative transactions.India's Forex Reserves Shrink $13 Billion To $734.6 Billion In Fourth Straight Weekly Decline Cuts forex derivative exposure threshold Under the revised directions, authorised dealers cannot permit customers to rebook rupee-linked foreign exchange derivative contracts cancelled after the directions were issued.The restriction covers both deliverable and non-deliverable contracts.However, contracts can still be rolled over upon maturity, provided existing regulatory conditions are satisfied.The RBI has reduced the threshold for undertaking certain foreign exchange derivative transactions without establishing underlying exposure from $100 million to $5 million.The revised limit applies across all authorised dealers.Similarly, the permissible limit for positions in exchange-traded currency derivatives involving the rupee, without demonstrating underlying exposure, has been lowered to $5 million across all recognised stock exchanges combined.To prevent multiple hedges against the same exposure, authorised dealers must obtain and retain customer undertakings confirming that the underlying exposure has not been hedged elsewhere. Introduces 20% forex risk reserve requirementThe central bank has introduced a Foreign Exchange Risk Reserve (FERR) for certain rupee-linked derivative transactions.Under the new requirement, authorised dealers must maintain a cash reserve with the RBI equal to 20% of the rupee value of the transaction's notional amount when it exceeds $2 million.The measure applies to specified contracts hedging current account exposures where customers purchase foreign currency against the rupee.Separately, the RBI is tightening daily cash reserve ratio (CRR) maintenance requirements for banks.From the reporting fortnight beginning Oct 16, banks must maintain at least 99% of their prescribed CRR each day, compared with 90% previously.The overall CRR rate remains unchanged, with the revised rule reducing banks' flexibility in managing daily liquidity.

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The RBI also introduced a foreign exchange risk reserve which will involve banks maintaining with the central bank - in cash - an amount equal to 20% of the rupee equivalent of the notional amount of each transaction which exceeds $2 million, it said.