The Reserve Bank of India updated and simplified guidelines for banks on unhedged foreign currency exposures of any business on Tuesday (October 11) to avoid losses due to increased volatility in the FX market.
The RBI has issued many recommendations, directions, and instructions to banks on Unhedged Foreign Currency Exposure (UFCE) of businesses that have borrowed from banks from time to time.
Following a bank’s request for clarification on several elements of UFCE, the RBI stated that a full assessment of the current rules had been completed, and all existing instructions on the topic had been consolidated.
According to a circular, these instructions will take effect on January 1, 2023.
The RBI stated in an official letter that any business’s unhedged foreign currency exposure is a source of concern for the individual entity and the broader financial system.
Entities that do not hedge their foreign currency exposure risk suffering considerable losses during periods of increased volatility in currency exchange rates.
According to the RBI, these losses can limit their ability to service loans acquired from the banking system and raise their likelihood of default, impacting the banking system’s health.
The RBI stated that if the possible loss from an entity’s UFCE is greater than 75%, banks must account for a 25 % increase in total risk weight in addition to the appropriate risk weight for that entity.
“This happens because exposures in the same bucket will have an equivalent rise in riskiness regardless of the original risk weight applicable,” the apex bank explained.