RBI Tightens Forex Rules with New Derivative Limits and FERR

The Reserve Bank of India has issued strict new circulars to tighten market discipline in the forex market, lowering hedging thresholds and introducing cash reserves.

The Reserve Bank of India (RBI) has announced sweeping regulatory updates aimed at ensuring the orderly functioning of the foreign exchange market. According to a press release issued by Chief General Manager Brij Raj, the central bank has rolled out two new circulars introducing stricter controls on foreign exchange derivative contracts involving the Indian Rupee (INR).

These policy adjustments arrive as part of the central bank’s ongoing strategy to enforce tighter market discipline and enhance institutional risk management frameworks. By scaling back unhedged position limits and creating dedicated cash reserve requirements, the central bank intends to curb speculative pressures and promote transparency across all authorised dealing platforms.

Key Regulatory Changes in the Foreign Exchange Market

Under the fresh directives, authorised dealers are no longer permitted to allow users to rebook any INR-linked foreign exchange derivative contract that has been cancelled after the issuance of the new directions. While standard rollovers at maturity remain permissible under existing regulatory provisions, the restriction on rebooking aims to plug speculative loops in the market.

Furthermore, the central bank has significantly lowered the threshold for undertaking foreign exchange derivative transactions without establishing an underlying exposure. Previously set at USD 100 million equivalent, the limit has now plummeted to USD 5 million equivalent across all authorised dealers and recognised stock exchanges for INR-linked exchange-traded currency derivatives.

• Rebooking of cancelled INR derivative contracts is strictly prohibited.
• Underlying exposure threshold slashed from USD 100 million to USD 5 million.
• FERR introduced at 20% cash requirement for qualifying derivative contracts over USD 2 million.

Introduction of the Foreign Exchange Risk Reserve

A notable addition in the central bank’s mandate is the establishment of the Foreign Exchange Risk Reserve (FERR). For all INR-linked foreign exchange derivative contracts carrying a notional value exceeding USD 2 million equivalent, authorised dealers must maintain an FERR in cash directly with the Reserve Bank.

This cash reserve must equal 20% of the INR equivalent of the notional amount of the transaction. The requirement applies specifically to derivative contracts undertaken to hedge current account exposures where market participants purchase foreign currency in exchange for the domestic currency.

What this means for investors

For Indian corporate hedgers, institutional participants, and market traders, these regulatory tightening measures mean increased operational friction and higher liquidity costs when managing foreign currency risk. The dramatic drop in the unhedged threshold from USD 100 million to USD 5 million means that far more transactions will now require rigorous verification of underlying exposures.

Additionally, the mandate to hold a 20% cash FERR with the central bank for large notional contracts will tie up capital for market participants engaging in current account hedging. Investors holding shares in major banking institutions and corporate entities with substantial cross-border trade should monitor how tighter derivative access impacts corporate hedging costs and currency volatility going forward.

Frequently asked questions

What is the new threshold for derivative transactions without underlying exposure? The threshold has been reduced from USD 100 million to USD 5 million equivalent across all authorised dealers and recognised stock exchanges.

What is the Foreign Exchange Risk Reserve (FERR)? It is a mandatory cash reserve equal to 20% of the INR equivalent of the notional amount, to be maintained with the RBI for specific contracts exceeding USD 2 million equivalent.

This article is for information only and is not investment advice. Do your own research or consult a licensed adviser before investing.

Based on information published by Reserve Bank of India (RBI). Source: Reserve Bank of India (RBI). Spotted an error? corrections@moneypuran.com