What changed
RBI noticed banks were swapping fixed-rate rupee liabilities on Innovative Tier I/II bonds into floating-rate foreign currency liabilities to hedge interest rate risk and reduce cost. This practice exposed banks to exchange rate risk, so RBI has banned new such swaps and set accounting rules for existing ones.
What it means for you
Banks can no longer use these swaps to lower funding costs on capital instruments, potentially increasing their interest rate exposure. Existing swaps must be accounted for conservatively: losses fully provided for, gains parked in a special reserve usable only for future losses on the same swap. This tightens risk management for capital market operations.
What you must do
- Stop entering into any new swap transactions that convert fixed-rate rupee liabilities on Innovative Tier I/II bonds into floating-rate foreign currency liabilities.
- For existing swaps, compute gains and losses separately; fully provide for any losses.
- Credit any gains to a special reserve through the P&L account; draw down only for future losses on the same swap.
- Do not renew any existing swap transactions on Tier I/II bonds upon expiry.
Who it affects
All commercial banks (excluding RRBs) that have issued Innovative Tier I/II bonds, Treasury and risk management departments handling derivative structures, Finance and accounting teams managing capital instruments
Why did RBI ban these swap transactions?
RBI found that banks were converting fixed-rate rupee liabilities on Innovative Tier I/II bonds into floating-rate foreign currency liabilities via swaps, which exposed them to undue exchange risk if exchange rates moved adversely.
What should we do with existing swaps already entered into?
Compute gains and losses separately. Fully provide for any losses. Credit gains to a special reserve through the P&L account, and use that reserve only to meet future losses from the same swap.
Can we renew existing swap transactions on Tier I/II bonds?
No, RBI has advised banks not to renew any swap transactions on Tier I/II bonds upon their expiry.