RBI clarifies interbank trades, ECBs coupons not part of FERR

The Reserve Bank of India (RBI) has clarified that the new foreign exchange risk reserve (FERR) will not apply to banks participating in market-making or taking proprietary positions. Additionally, FERR will not be required for interest on External Commercial Borrowings (ECBs), coupons on resident debt instruments held by non-residents, or dividends payable to non-resident investors, according to FAQs released by the central bank on Thursday.

The RBI's actions provide relief to banks who were uncertain about trading in the foreign exchange market following the imposition of a 20% cash reserve requirement on forex derivative contracts exceeding $2 million.

The FERR requirement pertains solely to derivative contracts where the user acquires foreign currency against rupees. The FERR for a specific derivative contract must be maintained until the day following its termination. This reserve must be deposited and managed in the authorized dealer's current account with the RBI on a daily basis. These funds will not generate interest and will not be classified as high-quality liquid assets (HQLA).

The new FERR requirement will not affect foreign exchange derivative contracts undertaken for the purpose of hedging capital account transactions, such as foreign direct investments, ECBs, or the issuance or transfer of equity shares. Banks should remain vigilant against any attempts to structure derivative transactions in order to circumvent these provisions.

The threshold of $2 million applies to the notional value of the single option with the highest notional value, and the FERR requirement will cease from the day following any partial cancellation of the derivative contract if the remaining notional amount falls below the applicable threshold.