Mumbai: Stock prices of private banks fell sharply on Monday on heavy selling by investors, following the central bank’s proposal to change accounting norms for the derivative contracts these banks have signed. It will significantly raise their capital needs and affect short-term performance.
Private banks with high exposure to derivatives fell more than their public sector peers, the Bombay Stock Exchange’s banking sector index and its bellwether Sensex index.
The draft guidelines of the Reserve Bank of India (RBI), announced late on Friday, say banks will have to compute and provide for their potential future credit exposure to interest rate and foreign exchange-linked derivatives.
Credit derivative exposures of these nature have traditionally been treated as “off-balance sheet” items. Once banks start providing for such exposures, it will directly impact earnings as it increases capital requirement. Also, the guidelines insist banks treat derivative exposures as they treat standard assets such as loans. It means if clients are not clearing their dues towards derivative contracts within 90 days, banks will have to classify them as non-performing assets, and provide for them.
The share price of private banks such as Kotak Mahindra Bank Ltd, Axis Bank Ltd, Yes Bank Ltd and Karnataka Bank Ltd fell more than 4% each.
Stocks of the two largest private sector banks in the country, ICICI Bank Ltd and HDFC Bank Ltd, suffered losses of between 3% and 4%. Except for Karnataka Bank, others have substantial exposure to derivatives and a few corporate clients are battling their bankers in court, alleging that bankers had mis-sold these financial instruments without informing them about risks.
The BSE Bankex index dropped 3.37%, while its benchmark Sensex closed at 16,063.18 points on Monday, down 2.15%.
Many private banks had sold complex derivative products to corporate clients to help them hedge against currency price fluctuations. However, many such deals have gone wrong, with the US dollar’s sudden weakness against other global currencies such as the Swiss franc and the Japanese yen.
Under the law, Indian banks cannot be directly exposed to such derivative products. They need to form a back-to-back arrangement with foreign banks for such deals. However, they always run a credit risk in case their corporate clients default. When the RBI guidelines take effect, these banks will have to provide for the delay by clients in payments related to such contracts. This will cause a slide in profits in the short term.
All the 18 scrips that form the BSE Bankex ended the day with losses. The country’s largest lender State Bank of India (SBI) lost 3.4%.
According to a late-May equity research report by foreign brokerage Merrill Lynch and Co. Inc., Indian banking stocks top the list of those over-owned by foreign institutional investors (FIIs). The report also says FIIs have cut exposure to the stocks of large private banks such as ICICI Bank and HDFC Bank. On the other hand, FII participation was strong in SBI’s rights issue earlier this year.