The Reserve Bank of India (RBI) has tightened forex derivative rules, reducing the exposure threshold from $100 million to $5 million. Announced on October 10, the measures aim to strengthen market discipline and ensure orderly functioning of the foreign exchange market.

The new rules restrict the rebooking of cancelled rupee-linked derivative contracts and introduce stricter requirements for managing currency risks. The RBI has also tightened documentation rules and introduced a reserve requirement for certain transactions.

Under the revised framework, authorized dealers cannot allow users to rebook rupee-linked foreign exchange derivative contracts, whether deliverable or non-deliverable, if the contracts were canceled after the directions were issued. However, rolling over contracts at maturity will remain permitted, subject to existing regulatory requirements.

The major changes include:

• Lower exposure threshold: The limit for undertaking certain forex derivative transactions without establishing underlying exposure has fallen from $100 million to $5 million.
• Exchange-traded derivatives: The corresponding limit for rupee-linked currency derivatives across all recognized stock exchanges has also been reduced to $5 million.
• Stricter documentation: Users must confirm that they have not hedged the same underlying exposure through another authorized dealer.
• New reserve requirement: Certain rupee-linked derivative transactions will require authorized dealers to maintain a cash reserve with the RBI.

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RBI Tightens Forex Derivative Rules and Risk Management

The revised forex derivative limit applies to transactions undertaken to hedge contracted exposures without establishing the existence of the underlying exposure. The changes cover transactions conducted through authorized dealers and exchange-traded currency derivatives involving the rupee.

The RBI has also introduced a Foreign Exchange Risk Reserve (FERR) requirement for specific rupee-linked derivative contracts. Authorized dealers must maintain a cash reserve with the central bank equal to 20% of the rupee value of each transaction's notional amount exceeding $2 million.

This requirement applies to rupee-linked foreign exchange derivative contracts used to hedge current account exposures when the user purchases foreign currency against the rupee.

The documentation changes are intended to prevent users from hedging the same underlying exposure through multiple authorized dealers. This could help strengthen oversight of foreign exchange transactions and encourage more disciplined risk management.

RBI Raises Daily CRR Maintenance Requirement

Alongside the forex measures, the RBI has tightened daily cash reserve ratio (CRR) maintenance requirements for banks. From the fortnight beginning October 16, banks must maintain at least 99% of their prescribed CRR on a daily basis, compared with 90% earlier.

The overall CRR ratio remains unchanged. However, the higher daily maintenance requirement will leave banks with less flexibility to manage their short-term liquidity needs. The move follows the RBI's October 9 announcement of an open market operation (OMO) sale of government securities worth ₹25,000 crore, scheduled for October 13. The sale is intended to absorb surplus liquidity from the banking system.

Market participants said the higher daily CRR requirement, combined with the planned OMO sale, could further limit banks' flexibility in managing day-to-day liquidity. Together, these measures reflect the RBI's focus on maintaining orderly foreign exchange market conditions, strengthening risk management, and managing liquidity in the banking system.