Mumbai: The Reserve Bank of India (RBI) has issued detailed norms for banks and primary dealers, asking them to trade in rupee interest-rate derivatives only with those who understand the risks associated with these products.
Derivatives are instruments—to be settled at a future date—whose value is derived from a change in interest rate, foreign exchange rate, credit rating, price of securities, or a combination of these.
In money markets, the rupee interest-rate derivatives and foreign-currency derivatives are allowed in India.
Interest-rate derivatives include interest-rate swaps, forward-rate agreement and interest-rate futures.
RBI, in its recent guidelines for rupee interest-rate derivatives, said it is imperative that market-makers offer derivative products only to those users who understand the nature of the risks inherent in these transactions.
Banks and primary dealers trade in derivatives to hedge future risks involved in exchange rate movements among other factors.
Pointing out that the rapid growth of the derivatives market, especially the structured ones, has increased the focus on suitability of these products, RBI said market makers should undertake such transactions with a sense of responsibility that would avoid mis-selling and other such issues.
Products being offered should be consistent with users’ business, financial operations, skills and sophistication, internal policies as well as risk appetite, RBI said.
Inadequate understanding of the risks and future obligations under the contracts by users, in the initial stage, may lead to potential disputes and thus cause damage to the reputation of market makers, the central bank said.
The guidelines also limited the size of a bank’s derivatives book to its net worth.