Violent fluctuations in currencies and interest rates in the past 18 months have led to a 30% surge in off-balance sheet exposure of banks as companies seek protection, but it leaves banks vulnerable in case of defaults.
The resurgence in the so called 'off-balance sheet items' is beneficial to banks where their income rises 0.08% for every percentage point increase in total exposure, but has the potential to damage the financial soundness of the banking sector.
Such transactions, which include forward contracts and guarantees, have risen to Rs 138 lakh crore by March 2011, up from Rs 105 lakh crore a year earlier. Foreign banks account for more than two thirds and the remaining with Indian private lenders.
Banks have very little exposure. "In the past one year, we have seen huge volatility in the currency markets on account of the global uncertainties," said Parthasarthy Mukherjee, head of treasury and international banking, Axis Bank. "Corporates are entering into forward contracts to hedge their foreign exchange exposures on account of overseas borrowings and trade exposures," he added.
Interest rates have been rising in India with RBI raising policy rates 13 times and the mark-up over the Libor, a global benchmark, has also been volatile for companies from emerging markets. The rupee has lost nearly 15%, triggering calls for intervention by RBI, which it has ruled out at least for now.
"Off-balance sheet exposures raise concern as its exact impact on the soundness of the banking sector is uncertain," the central bank said in its Report on Trend and Progress of Banking in India released this week. "In the event of a default, these exposures can seriously damage the financial soundness of the banking sector, especially those of foreign banks and new private sector banks," the report added.
But these contracts are essential for many companies which have borrowings in US dollar, or get revenues from overseas. So if they need to limit their liabilities in the event of dollar appreciation as it is now, they need to hedge it through banks. "It would be natural to assume that in the given uncertain environment, hedging of forex exposures would have increased," said Ajay Marwaha executive VP and head of trading, HDFC Bank.
"In an environment where liquidity is stretched, banks have been looking for non-fund-based revenues," he added.
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