The regulator said these transactions are partly responsible for sharp depreciation in the rupee against the dollar.

The Reserve Bank of India (RBI) has cracked the whip on some of the large foreign banks in the country for encouraging companies to participate in speculative trades in the foreign exchange market.

The banking regulator in a meeting with senior representatives of foreign lenders have cautioned them for taking part in these trades, as it felt these transactions were partly responsible for sharp depreciation in the rupee against the dollar, three people familiar with the development said. Foreign banks were acting as arrangers for the companies in these transactions.

“RBI was aware that many foreign banks were encouraging speculation in the market. But it could not take any action as most of these trades were done offshore outside its regulatory purview. There was a meeting last month where RBI issued oral warning to some of these banks,” said a source privy to the discussions with the regulator.

According to industry players, most of these speculative trades were done taking advantage of the difference in forward premium rates in India and non-deliverable forward (NDF) contract market abroad.

According to bankers, the difference in forward premium rate in India and NDF market, which widened sharply in the second half of 2011, offered a perfect opportunity for banks and corporates to benefit from the rupee’s depreciation.

Industry sources said between August and December many large corporate houses were approached by banks to take part in foreign exchange trades in India and NDF market through subsidiaries and associates.

They will enter into a contract to buy dollar in India, while their subsidiaries will take another forward sale contract in the NDF market with a view that rupee will depreciate further. The difference in forward premium rates in the two markets allowed the corporates to benefit from these simultaneous trades.

“Banks were getting a hefty fee for arranging these transactions,” said another person aware of these deals. Adding: Often the lenders were getting as much as one-third of the windfall.

These trades were believed to be one of the reasons for volatility in the Indian rupee movement in the latter part of 2011. The Indian currency depreciated by almost 18 per cent in less than six months between August 5 and December 15 with the volatility as measured by annualised standard deviation of daily percentage changes doubling from five per cent to 12 per cent.

“Primarily, to discourage these trades RBI came out with the new guidelines. The opportunity to gain from arbitrage is hardly there anymore as the difference in forward premium rates in India and NDF market has narrowed,” said an independent foreign exchange analyst.

On December 15, RBI restricted rebooking of cancelled forward contracts and reduced the net overnight open position limit or trading limits for banks in the foreign exchange market. (Business Standard)