The Telegraph
Since 1st March, 1999
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Banks, FIs can deal in interest rate derivatives

Mumbai, June 3: The Reserve Bank of India (RBI) today announced that commercial banks, primary dealers and financial institutions can transact in interest rate derivatives (IRDs) on the country’s bourses.

In the first phase, these entities can transact only in interest rate futures on notional bonds and T-Bills for the limited purpose of hedging the risk in their underlying investment portfolio.

Allowing transactions in a wider range of products, as also market making will be considered in the next stage on the basis of the experience gained, the central bank added.

The RBI said that for the present, only the interest rate risk inherent in the government securities classified under the ‘available for sale and held for trading’ categories will qualify for hedging. For this purpose, the portion of the ‘available for sale and held for trading’ portfolio intended for hedging must be identified and carved out for monitoring purposes.

“IRD transactions undertaken on the exchanges shall be deemed as hedge transactions, if and only if the hedge is clearly identified with the underlying government securities in the ‘available for sale and held for trading’ categories,” the central bank observed.

According to the RBI, while derivatives present immense opportunity for mitigating the market risks inherent in the balance-sheet, it can also expose one to substantial losses on account of inadequate understanding of the product, absence of proper monitoring, poor risk control measures.

Banks and financial institutions desirous of transacting in IRDs on the bourses should take specific approval from their respective boards covering the products that they may transact in, size/composition of the investment portfolio intended for hedging, organisational set-up to monitor, report, account and audit such transactions.

“Further, it is desirable that derivative desks are created within the treasury and management level responsibility clearly assigned,” the RBI said in a notification.

Such entities can become members of the futures and options segment (F&) of stock exchanges to undertake such transactions, or transact through those who are members.

RBI added it will hold discussions with market players at a later stage to review current guidelines and progress to the next phase.

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