RBI Mandates Banks To Align Foreign Exchange Risk Capital Charges with International Standards

RBI Mandates Banks To Align Foreign Exchange Risk Capital Charges with International Standards​

Reserve Bank Aligns Forex Risk Computation with Global Standards​

The Reserve Bank of India (RBI) has issued a notification mandating commercial banks to align their computation of capital charges for foreign exchange risk with international standards. This move underscores the central bank's commitment to consistent and rigorous financial oversight across all Regulated Entities (REs).

Banks are now required to compute Net Open Position and maintain capital charges for foreign exchange risk at both a group or consolidated level, as well as at a solo or standalone level. The RBI stipulated that these calculations must be performed continuously, specifically at the close of each business day.

The central bank stated that the amendment is being introduced "Upon a review and to ensure greater alignment with international standards and consistent implementation across commercial banks." These new directions are slated to come into effect from April 1, 2027.

New Guidelines Focus on Capital Risk Mitigation​

To provide clarity and certainty, the RBI specified several exclusions concerning foreign exchange risk capital requirements. Banks are exempt from applying this capital requirement to any position that is deducted from the bank's regulatory capital, including positions specifically designed for hedging such a position.

Furthermore, holdings of capital instruments that are either deducted from a commercial bank's capital or are risk-weighted at 1,250 percent do not need to be included in the forex risk capital requirements.

The RBI also clarified that securities which have already matured and remain unpaid, or those classified as non-performing assets/investments, should only attract capital for credit risk, and not for foreign exchange risk.

Strategic Exclusions for Structural Investments​

The central bank offered banks an option to exclude certain structural foreign currency investments from the calculation of Net Open Position. This exclusion can be applied on both a standalone and a consolidated basis.

This exclusionary measure is limited strictly to the amount that neutralises the sensitivity of the capital ratio to movements in exchange rates, provided the exclusion has been maintained for at least six months.

The RBI emphasized the distinction between matched currency risk positions and capital adequacy protection. While a matched currency position will protect a bank against losses from exchange rate fluctuations, it does not inherently guarantee its capital adequacy ratio remains stable.

Protecting Capital Adequacy Ratio vs Matched Positions​

The notification detailed that even if a bank has a portfolio of foreign currency assets and liabilities that are completely matched while its own capital is denominated in the domestic currency, its capital/asset ratio could still fall should the domestic currency depreciate.

To counter this risk, the RBI noted that running a short risk position in the domestic currency can protect a bank's capital adequacy ratio. However, it cautioned that such an action may result in a loss if the domestic currency appreciates.

Differential Requirements for Rural and Small Finance Banks​

The new instructions introduce tiered requirements based on the type of institution. Currently, a small finance bank is not required to calculate or maintain a capital charge for foreign exchange risk.

However, any small finance bank operating as an Authorised Dealer Category I bank will be obligated to monitor its net open position. Risk weights related to Net Open Position will be applicable only to those regional rural banks designated as Authorised Dealers.

For other regional rural banks, the RBI specified that they may calculate the risk weights on Net Open Position by considering solely the net open position originating from gold.