A Better System of Controls Needed
article written by Tejinder.
Friday, 14th March, 2008
On December 2007, according to government of India said that Indian banks had Rs.127 lakh crore exposures to derivatives. This has surely set alarm bells ringing, as the ICICI bank declaring mark to market losses on foreign credit derivatives and fixed income investments and L& T declaring that it could be taking Rs 200 crore hit on its commodity hedges.
It is difficult to quantify the exact risk though this is for sure that the entire amount is not at risk. There is an exposure to plain forex hedges out of this reported 127 lakh crore and it is a substantial portion. A large chunk of the headline figure are bank-to bank derivatives, i.e., a bank writing a derivative contract for a corporate does a back -to-back contract with another bank.
There may be a hit on the corporate profit growth in the coming quarters as non-operating income falls because of derivatives losses. Well the brighter side, if one can call it that, is that corporate balance sheets are strong and in most cases losses won’t be crippling. Next time banks and corporates should be more circumspect as the reality of overseas derivatives cannot be wished away. India’s increasing integration with global markets - through trade, global sourcing of inputs, and overseas investments by corporates, foreign borrowing and expansion of Indian banks overseas - means that exposure would have to be hedged. What is needed is a better system of controls. Banks should think twice before selling exotic derivatives to customers who have no clue about the risks. Companies need to put in place systems to ensure speculative investments are authorized and within prudent limits.
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