Mumbai: Kotak Mahindra Bank Ltd has made provisions of Rs86 crore to cover liabilities after its customers recorded mark-to-market losses of Rs612 crore on derivatives.
Kotak Mahindra faces the threat of litigation by customers who have lost money on derivatives, Uday Kotak, vice-chairman of the bank, said in an interview with CNBC TV 18.
Derivatives are financial instruments used for speculation and as insurance against fluctuations in the markets. Their value is based on prices for currencies, stocks, bonds, loans and commodities, or linked to events such as changes in foreign exchange rates.
Mark to market is an accounting practice of assigning a value to a position held in a financial instrument based on its prevailing market price.
Indian companies may lose $4 billion (Rs16,560 crore) on derivatives, Hong Kong-based brokerage CLSA Ltd said. Several firms that face such losses have filed lawsuits against banks, including ICICI Bank Ltd, Kotak Mahindra Bank and Axis Bank Ltd, accusing them of hiding risks inherent in derivatives to attract small businesses into derivatives contracts they didn’t understand.
Banks say clients were fully aware of the risks. “We maintain records to show that companies knew what they were getting into,” Madhabi Puri-Buch, executive director at ICICI Bank, said earlier.
Indian banks may lose Rs1,600 crore if they can’t enforce the contracts with smaller firms, according to CLSA. The estimate is based on the assumption that 10% of the firms may renege on the pacts.
On Friday, Kotak Mahindra, the worst performer in the Bombay Stock Exchange’s index of bank stocks this year, said fourth quarter profit rose 41% as higher lending boosted revenue. Net income climbed to Rs240 crore from Rs170 crore a year earlier. That included profit from its brokerage, investment banking and insurance units.
The bank aims to open more retail branches and seek new depositors and borrowers to offset a drop in income from arranging share sales as the global credit squeeze deters firms from raising capital. It’s benefited from corporate clients seeking funding to expand in an economy that grew 8.7%.
“Equity market volumes have declined sharply in the last two to three months, and Kotak’s market share is under pressure as well,” Aditya Singhania, an analyst at Credit Suisse Group, said in a note to clients before the earnings announcement. Singhania, who rates the stock “under-perform,” cut the price target on it to Rs708 a share from Rs883.
The lender said the estimate on clients’ mark-to-market losses was as of 8 May. Shares of the bank fell 5.7% to Rs738.55 each in Mumbai trading. The stock is down 43% this year, compared with the Bankex index’s 25 % decline.
“One should change tack,” Kotak said. “It is back to the basics of the spreads business, that’s the key which you would see in the next 12 months.”
Several banks have made provisions to cover for losses if their customers challenge these transactions in court. Axis Bank has provided for Rs71.97 crore to cover for two firms that have incurred losses and filed court cases against it.
ICICI Bank, too, has made provisions of Rs400 crore in the quarter ended 31 March. This is, however, on account of mark-to-market losses for the bank’s exposure in credit derivatives obligation and credit-linked notes. Under the law, Indian banks cannot have a naked or uncovered exposure to cross-currency derivatives. This means all cross-currency options and swaps of their customers are hedged back-to-back with the same tenure and amount with foreign banks. If a company defaults, banks will have to pay to settle the contracts with counter-parties (in this case, the foreign banks).
India’s largest lender, State Bank of India, has made no provision for such losses, but said last week that it was ready to extend a fresh line of credit to its corporate clients to tide over such losses. (Bloomberg)
(A Mint staff writer contributed to this story)