RBI Slams Banks Over 'Arbitrage Games' as Forex Regulator Intensifies Scrutiny on Rupee Stability

Regulator Targets Bank Practices in Currency Market Volatility​

A senior Reserve Bank of India official has publicly criticized foreign-exchange market makers regarding their activities. The criticism focuses on their role in reportedly aggravating the rupee’s weakness, particularly during periods of heightened tension in the Middle East.

Deputy Governor T. Rabi Sankar made these remarks during an annual foreign exchange dealers’ conference in Paris over the weekend. Sources familiar with the matter indicated that Sankar specifically addressed the arbitrage trading activities between local and offshore currency markets.

According to these sources, the arbitrage was observed to be straining dollar liquidity at a critical juncture. This strain occurred precisely when the rupee was already facing pressure due to large foreign outflows.

RBI Imposes Strict Controls on Forex Speculation​

These remarks follow decisive regulatory action taken by the RBI just two weeks prior. The central bank clamped down on speculation targeting the rupee by capping currency bets made by banks at $100 million each.

Furthermore, the RBI also barred these banks from entering derivative contracts within the offshore market. These stringent restrictions proved significant, forcing banks to reverse an estimated $30 billion worth of arbitrage trades.

These reversed trades involved a pattern where banks had bought dollars in the local market and subsequently sold them in the offshore market.

Concern Over Offloading Trading Exposures to Corporates​

Sankar's commentary also signaled the regulator’s strong displeasure with how banks managed their risk. Sources cited that Sankar criticized banks for transferring arbitrage trades from their own books to corporate clients.

This was noted despite the fact that companies are not permitted to undertake such complex currency transactions. The RBI’s apprehension extended to other methods banks used to shed their risk exposure.

The regulator also disapproved of certain other means through which banks were taking these trades off their books.

Building Concern Over Arbitrage Positioning​

The regulatory caution has roots in concerns raised previously. Last week, RBI Governor Sanjay Malhotra had noted the build-up of arbitrage positions. These positions were forming between the offshore and local markets towards the end of March.

While such linkages are vital for efficient price discovery under normal market conditions, Malhotra cautioned against excessive volatility. He warned that a rapid build-up of these positions could prove destabilizing.

Market Response and RBI's Commitment to Stability​

Despite the sharp regulatory tone, the RBI has maintained that its current currency market curbs are temporary. Governor Malhotra clarified that these measures would not remain in place indefinitely.

The local currency has shown notable resilience since the RBI first intervened to support the battered rupee. The rupee, which had previously hit record lows and was approaching the 100 per dollar mark, has since gained around 2%.

This performance has positioned the rupee as the best performer in Asia year-to-date. This strength was partly attributed to banks unwinding their bearish rupee bets to comply with an April 10 deadline.