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Business News/ Industry / Are banks resorting to unfair practices to ensure forex hedging by small firms?
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Are banks resorting to unfair practices to ensure forex hedging by small firms?

Govt banks deny forcing SMEs to hedge, admit that rates charged for hedging could differ for different sizes of loans

Companies and currency consultants say that banks may be taking advantage of the situation. Photo: MintPremium
Companies and currency consultants say that banks may be taking advantage of the situation. Photo: Mint

Mumbai: Banks are arm-twisting small- and medium-sized companies to hedge their foreign currency loans at exorbitant rates, sometimes threatening to choke off future credit or not sell them dollars unless they hedge.

While the decision on hedging foreign currency exposure lies with a company, in January 2014, the Reserve Bank of India (RBI) said that banks would have to make higher provisions against accounts that have unhedged forex exposures. This led to banks pressing their clients, especially small- and medium-sized companies, to hedge, sometimes at a high cost.

RBI’s concern on unhedged exposure is valid given the risk this could pose to the country’s financial stability. In a speech on 4 October 2014, RBI deputy governor H.R. Khan said proportion of external commercial borrowings and foreign currency convertible bonds that are hedged declined rom 35% in 2013-14 to just 15% in July-August 2014.

Companies and currency consultants say that banks may be taking advantage of the situation.

Hedging refers to contracting an exchange rate for a future date, by paying a premium over the prevailing spot rate. An exporter hedges to lock in a favourable exchange rate when he expects the rupee to strengthen against the dollar in the future. An importer hedges if he feels the currency will weaken in the future, potentially pushing up his import bill.

While hedging, apart from the interbank rate, banks add a credit charge to the transaction. A credit charge is a credit risk premium charged by banks.

This charge, according to currency consultants, varies widely. For example, banks may charge seven paise per dollar to a mid-cap client, but almost 20 paise per dollar to a small company. For large companies, the credit charge is sometimes almost non-existent.

“That’s a bit unfair," said Samir Lodha, managing director at QuantArt Market Solutions Pvt. Ltd, a foreign exchange consultant.

A.V. Rajwade, one of India’s best known finance consultants, agrees.

“I agree that there is a pressure on banks from RBI to see that their clients are not unhedged, but that does not mean extortionate margins or taking advantage of ignorance of the clients," said Rajwade.

Margin refers to the bank’s profit over the exchange rate at which a contract is executed. This can be a fixed amount, but mostly it is charged on a per dollar basis.

Rajwade blamed the reward system of banks, particularly private and foreign banks, which allows their marketing executives to earn fat bonuses on the fee income generated by them.

However, Rajwade sees some justification in banks charging more for small-value transactions because of the fixed cost involved.

State-owned banks deny they are forcing small enterprises to hedge, often at high rates, but admit that the rates charged for hedging could be slightly different for different sizes of loans.

The treasury head at a state-owned bank said smaller loans come at a higher price because the processes and documentation involved for any loan ticket size remain the same.

“If a large corporate asks for a loan of a few thousand dollars, the rates will be different than if the same corporate asked for a million dollar loan. The same goes about any client of a bank, irrespective of the size of the client," added this person who spoke on condition of anonymity.

Explaining the difference in exchange rate charged to smaller banks, a head of treasury with a foreign bank said small companies often ask for foreign exchange loan of $1,000 to $10,000, which a bank cannot process immediately. A bank has to borrow dollars from the interbank market where the minimum lot size is usually $1 million. The bank has to wait for the aggregate demand to be at least half a million dollar before it can enter into the market to buy the greenback. By the time the dollar is procured, the exchange rates may move significantly.

“We can’t give such small loans at the market rate prevailing in the exchanges. The reason why big companies get dollars at a much cheaper rate is because we can just pick up the phone and buy the dollars immediately from the market," said the treasury head who asked not to be identified.

That doesn’t explain why smaller companies have to pay higher margins, though.

“The difference in margin between small and large client is easily five-six times. If large clients pay a margin of half a paisa per dollar, SMEs pay three paise," said Lodha of QuantArt.

The margin on top of the hedging cost of 6-7% over the spot rate means loans become costlier.

But costly loans is just one of the problems small enterprises face.

No dollars

“Since the last six months or so nationalized banks are refusing to give us dollars (unless the loan is hedged). They say take rupee loan at 9-12% and convert it in the open market to dollars," said Satish Wagh, chairman of Basic Chemicals, Pharmaceuticals and Cosmetics Export Promotion Council, or Chemexcil.

There may be a legitimate reason for banks to refuse dollars to smaller clients, in light of recent experiences.

Last year, some small and mid-sized companies contracted with banks to buy dollars at 66-67 levels when the exchange rate was at 64-65 a dollar. But when the currency appreciated to 58 a dollar, they accused banks of misleading them and refused to honour the contracts. There have also been instances of bill discounting frauds where the clients produced fake foreign bills to get dollar loans from banks. Finally, banks have a limit on open positions set by RBI, which they prefer not to exhaust in case a large client needs dollars.

Wagh says that many a times, smaller clients have no option but to succumb to the bank’s pressure to take a fully hedged loan at an exorbitant rate offered by the same bank.

“One of the easier ways adopted by many public sector banks is to tell SMEs that foreign currency lending will be done only on hedged basis, else no such loan will be given. These companies are dependent on banks for funding," said Lodha.

In the case of larger clients, banks may not be in a position to dictate such conditions.

What’s the solution?

According to Rajwade, small companies can reduce their dependence on banks by moving to the exchange traded markets.

Between the three exchanges, BSE Ltd, National Stock Exchange of India Ltd, and MCX-SX, the daily volume traded on currency derivatives is generally around 30,000 crore—at par or higher than the OTC (over the counter) markets. Besides, in an exchange-traded market, a small company can buy in lots of $1,000, without waiting for a bank to execute a deal on its behalf.

However, the reason companies still have to deal through banks is because the Indian rupee is still not fully convertible.

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Published: 25 Feb 2015, 12:47 AM IST
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