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Sep 14, 2013

RBI Files Affidavit in Forex Derivative Case

image As per the direction from the Supreme Court, Reserve Bank of India filed an affidavit on violations which were identified by the Inter-Departmental Group in respect of the 19 banks and the action taken by the RBI against those 19 banks.
The issue of the loss suffered on account of exotic derivative contracts sold by banks came up before Justice R.M. Lodha, Justice J. Chelameswar and Justice Madan B. Lokur for hearing.
In response to the said order the Reserve Bank of India has filed its affidavit and the case is slated for hearing now on the 24th of September 2013.
During the year 2007, few banks started aggressively marketing certain exotic foreign exchange derivative contracts projecting the same as an alternative profit making mechanism available to exporters whereas actually these contracts had exposed the exporters to enormous risk. Within few months, the contracts started resulting in huge losses to the exporters.
 A PIL was filed before the Orissa High Court by Mr. Pravanjan Patra seeking direction to order for a CBI probe on the issue of Forex derivatives. Besides confirming to the violations, RBI also mentioned that the total Mark to Market loss in respect of these derivative contracts was to the tune of Rs. 31,719/- crores and the unrealised dues by banks was Rs. 755/- crores.
Gist of Violations : 
 A gist of the said violations are given below : 
1. Offering structures resulting in increase of risk to the corporate and receipt of net premium by the corporate;
2. Offering leveraged structures;
3. Failure to verify the underlying / adequacy of the underlying;
4. Not obtaining declaration regarding amounts booked with other Ads under past performance route;
5. Booking of contracts under the past performance route beyond the 50 % of eligible limit without obtaining CA Certificate;
6. Failure to ensure adherence to the eligible limit under the past performance route;
7. Failure to obtain review reports and annual audit reports from the corporates;
8. Failure to carry out proper due diligence regarding user appropriateness and suitability of products before offering derivative products to users;
9. Failure to obtain written acknowledgement from clients for understanding risks disclosed;
 In addition to the above, the RBI vide its affidavit before Supreme Court dated 04.06.2013 has pin pointed ten more violations as listed below: 

1. Offering structures other than plain vanilla options;
2. Offering option contracts to hedge derived exposures;
3. Offering structured products ignoring the customers’ sophistication level;
4. Failure to document pricing and valuation;
5. Defect in policy – not incorporating provision prohibiting deals with customers without risk management policies on their own;
6. Failure to provide sensitivity analysis;
7. Failure to provide calculator or atleast access to a calculator which will enable the users to mark to market structured products on an ongoing basis;
8. Failure to share with the user, scenario analysis encompassing both the possible upside as well as downside;
9. Failure to share with the user description, building blocks and rationale of the transaction;
10. Failure to put in place acceptable methodology for quantifying financial risk in derivatives;