Citibank said it ensures that its clients are provided with adequate scenario analysis and risk disclosures. “We always focus on the ‘suitability’ and ‘appropriateness’ procedures that covers the client’s underlying business model, nature of underlying exposures, sophistication of the management in understanding derivatives, company’s experience in using derivatives in the past and levels of decision making within the company and authorization for transacting derivatives,” said Sanjay Nayar, CEO, Citi India.
Bankers blame the dollar’s weakness against global currencies for the turn of events. Over the past year, the euro has appreciated 17.8% against the dollar, yen more than 16%, and Swiss franc (SF) some 21%, making most of the bets against currency movement go horribly wrong. Thus, a company that transformed its dollar liability into a yen or SF liability through complex derivatives faces significant losses. Typically, these have “knock-out” and “knock in” clauses. While these options protect a firm’s yen or SF exposure against dollar depreciation, this is only till a certain level; once the dollar’s weakness crosses this, the “knock-out” clause is triggered, leading to losses. Similarly, if the dollar rises and touches the “knock in” level, the customer makes money. As the dollar continues to depreciate, losses increase, and companies can either terminate the deals midway or wait till they are mature, hoping that by that time the currency movement would have been reversed.
Accounting norms are not very clear whether Indian firms need to book the notional losses, known as mark-to-market (MTM) losses. No one is sure about the quantum of total MTM losses at this point. The figures floating in the market for such losses are between $2 billion and $7 billion. KPMG’s Sanwalka put the MTM “hole” in corporate balance sheets at around $2 billion. Kotak Mahindra Bank’s Gupta said it could be between $2.5 billion and $3 billion but added that they are “not losses”. Market estimates put MTM losses for Axis Bank’s customers at around Rs400 crore and that for Kotak Mahindra’s around Rs600 crore.
No more option selling
Kotak Mahindra Bank stopped selling such products in November. And other banks said that firms’ appetite for such products has gone down. Risk management consultants, however, said the demand was never there and banks led the firms up the garden path. “Banks have sold structured proprietary products where pricing is non-transparent and risk less than transparent. Globally, banks like complex options as their margin is high,” said Rajwade. Desai of J Sagar added that banks normally target small and medium enterprises (SMEs) to sell such products as these firms are not treasury savvy. Shroff of Amarchand and Mangaldas strongly refuted the allegation of mis-selling. “They were not sold to retail customers...sophisticated treasury managers have bought them.”
Partha Mukherjee, treasury head of Axis Bank, said exposure of the SME clients of banks to such products is insignificant. HDFC Bank said it has not sold any complex structured products to small firms. According to Citibank’s Nayar, Citi’s overall derivatives exposure across SME clients actually favours the clients.