Indian banks are set to face heightened uncertainty on Thursday after the central bank’s
curbs on corporate activity made it costlier for lenders to cut
arbitrage positions, potentially saddling them with larger
losses.
Late on Wednesday, the Reserve Bank of India barred banks
from offering rupee non-deliverable forwards to resident and
non-resident clients.
The move was aimed primarily at halting a surge in
corporate-driven arbitrage activity seen on Monday, four bankers
said, requesting anonymity since they are not authorised to
speak to the media.
With corporates no longer able to arbitrage between the
onshore and NDF markets from Thursday, banks will find it harder
and more expensive to unwind positions the RBI has asked them to
cut, they said.
The central bank, in effect, was directing lenders to cut
arbitrage positions that were considered lucrative and low-risk
and were compounding the pressure on the rupee.
On Monday, banks had relied on corporate arbitrage flows to
help reduce exposures in line with the RBI’s earlier directive.
“Banks that did not cut on Monday and chose to wait will now
have to pay a much steeper price,” a senior treasury official at
a private sector bank said.
“The market knows they need to cut positions and have little
choice, and will demand a premium.”
Bankers estimate sizeable positions are outstanding. Of the
estimated $30 billion-$40 billion in arbitrage exposure, only
around 50%-60% were unwound on Monday, leaving a substantial
overhang in the system.
The treasury official said his bank, along with most foreign
banks, had reduced positions to within RBI limits on Monday,
while most state-run banks were yet to fully exit.
STEEP COST
Banks saddled with positions now face a tougher exit path
following Wednesday measures.
The cost of cutting positions to RBI levels largely depends
on the spread between the onshore market and the offshore NDF. A
wider spread raises the cost of unwinding positions, and
consequently, increases losses.
The spread in the 1-month tenor had widened to nearly 100
paise on Monday before narrowing to around 30-40 paise, helped
by corporate arbitrage activity.
With those arbitrage flows now curtailed, the spread has
widened again to about 100 paise on Thursday, lifting exit costs
for banks.
SUPPORTING RUPEE
The RBI’s clampdown on position limits of banks was aimed at
supporting the rupee, which has been under pressure from
persistently high oil prices linked to the Iran war.
However, the impact was blunted when corporates stepped in
to exploit arbitrage opportunities, contributing to the rupee
slipping to an all-time low of 95.21 on Monday.
Analysts said the crackdown on corporate arbitrage was aimed
at plugging a loophole that had hindered the rupee’s rise.
“The latest set of measures by the RBI marks a clear and
coordinated shift towards tightening speculative activity and
reasserting control over rupee dynamics,” Kunal Sodhani, head
treasury at Shinhan Bank, said.