Mumbai: Contingent liabilities, or so-called off-balance sheet exposure of banks, increased nearly 75% in 2006-07 as more companies rushed to hedge their foreign exchange contracts to tide over volatile currency markets.
Off-balance sheet exposure, including derivatives, letters of credit and guarantees, are called so because they are not directly funded by banks and do not appear on their balance sheets.
However, these remain liabilities on the books of banks, which will have to honour the commitment if their client companies fail to do so.
“These off-balance sheet items could pose liquidity risk to the banks if not monitored as banks would have to honour commitments if companies don’t meet their obligations,” said the treasurer of a private bank who did not want to be named. “This is evident from the current forex derivative issues between banks and companies.’’
According to data from the Reserve Bank of India, such exposure of public, private and foreign lenders increased to at least Rs74 trillion at the end of March 2007, from about Rs42.5 trillion the previous year. Data for the year ended March 2008 was not available.
Foreign banks, which had the largest exposure to forward exchange contracts, increased their off-balance sheet exposure by 97.73% to Rs50.5 trillion in 2006-07 from Rs25.5 trillion earlier.
Balance sheet chink: The total exposure of all lenders in India stood at Rs74 tr in March ’07. Indranil Mukherjee / AFP
And new private sector banks increased their exposure by 59.23% to around Rs12.6 trillion in 2006-07, while public banks did so to Rs10.5 trillion from Rs8.4 trillion.
“We have seen an increase in the off-balance sheet exposure of banks as business in the forward exchange market increased,” said a senior executive with a private sector bank who did not want to be named. “Many banks entered into simple and exotic forward contracts to hedge themselves against currency fluctuations.’’
Foreign banks, he said, also had high exposure to guarantees and derivatives as their clients have exposure to various currencies and need to hedge positions. Their forward exchange contracts doubled to Rs42.2 trillion from Rs21.8 trillion earlier.
Typically, off-balance sheet items include direct credit substitutes in which a bank substitutes its own credit for a third party’s, including standby letters of credit, irrevocable letters of credit that guarantee repayment of commercial paper or tax-exempt securities, so-called risk participations in bankers’ acceptances, interest rate swaps, interest rate options, and currency options.
Of these, derivatives have gained much attention this year as private banks such as ICICI Bank Ltd, HDFC Bank Ltd, Kotak Mahindra Bank Ltd and Yes Bank Ltd are fighting cases related to alleged mis-selling of exotic forex derivatives to companies, after some of these hedges went sour.
Sundaram Brake Linings Ltd, Rajshree Sugars and Chemicals Ltd, NCS Sugars Ltd and Sundaram Multi Pap are some of the companies that have gone to court against their banks for selling them such derivative products.
According to a statement tabled in the Rajya Sabha by finance minister P. Chidambaram in March, banks’ exposure to derivatives had increased to Rs127.86 trillion as on 31 December 2007. Among Indian banks, ICICI Bank had the largest exposure at Rs7.67 trillion. HDFC Bank Ltd had an exposure of Rs5.04 trillion and state-run State Bank of India, Rs4.68 trillion.
In a recent notification on prudential norms for off-balance sheet exposure of banks, the banking regulator said only the amount due to banks under derivative contracts that remained unpaid for 90 days or more from the specified date of payment would be classified as non-performing assets, or NPAs.
The regulator also clarified that the larger issue of considering the entire amount of receivables as NPAs is under consideration and a separate communication would follow, if required.
“The RBI notification to treat it (a derivative contract that remains unpaid) as a non-performing asset makes the bank case strong as banks can now treat it at par with any other loan default,’’ said the chief executive officer of a private sector bank who did not want to be named.