When a change in RBI Act led to a giant scam

Gangadhar S Patil l Mumbai

It was an amendment to the RBI Act in July 2006 that paved the way for banks to mis-sell exotic derivatives to companies, which led to losses of Rs32,000 crore, according to experts.

Normally, customers are required to pay a premium to enter into an exotic derivatives contract. But the amendment allowed what are called “zero-cost option structures” where customers don’t have to pay any premium. Since banks did not charge a premium, they passed on the risk of monetary loss through exchange rate fluctuations to traders, said S Dhananjayan, a chartered accountant based in Tiruppur, the town that was at the centre of the derivatives’ losses scam. “Never in the history of India had these kinds of derivatives sold by banks,” he added.
“The insertion of a new clause (zero-cost structure derivatives) in the RBI master circular was the real devil, and we have internal notes of the central bank to prove that this amendment was brought at the behest of authorised dealers (who deal in foreign exchange),” said Vinod Kothari, a Kolkata-based chartered accountant. “However, the details of the banks involved are yet to be known,” he added. The clause was incorporated sans any noise in 2006, and was effective until 2011. Though it is a case of supervisory failure on the part of the RBI, which operates under finance ministry, the then finance minister, P Chidambaram, refused to intervene in the matter saying it involves private and foreign banks so the government cannot interfere.
“Chidambaram refused to entertain us when we went to represent our case in 2008,” said Raja Shanmugam, president of Forex Derivative Consumer Forum, a forum of traders who lost money due to exotic derivatives. It was apparent from the 2005 budget speech of Chidambaram that he was favouring legal status of such derivatives. “Over the counter (OTC) derivatives play a crucial role in mitigating the risks of corporate, banks, and other financial entities. There is, however, some ambiguity regarding the legality of OTC derivative contracts, which has inhibited their growth. I, therefore, propose to take measures to provide for clear legal validity of such contracts,” read the FM’s speech.
It was around the same time that Lehman Brothers entered India by opening its first office in Mumbai. As per its 2006 annual report and the minutes of one of its board meetings, Lehman was planning to expand in India in various finance sectors. In 2011, the RBI penalised 19 banks — including the country’s top private and foreign banks — slapping fines of Rs10-15 lakh for violating its guidelines on derivatives. But as per the RBI Act, the penalty should not exceed Rs5 lakh or twice the amount involved in such contravention, whichever is more. The crucial point is, “whichever is more”.

“As per the RBI’s own submission, the losses are around Rs32,000 crore. Then why did the RBI levy such small penalties?” Is the RBI trying to hush up the issue, Dhananjayan asked. Despite repeated attempts, RBI officials were not ready to comment. Names of many banks involved in the scam haven’t come out either.

Banks used exotic means to hoodwink Reserve Bank

Gangadhar S Patil l Mumbai

Banks adopted various ways to sell illegal and ‘exotic’ derivatives in their profit pursuit, bypassing the Reserve Bank of India’s (RBI) guidelines and causing losses of as much as Rs34,000 crore, which they then tried to cover up by forging documents, DNA investigations have found. Banks sold these contracts to gullible companies, taking advantage of a depreciating dollar against the rupee, and offering exporters what they needed — an alternative to offset their currency losses.
In 2007, the rupee rose rapidly to Rs39 from around Rs50 per dollar, causing panic among Indian exporters who feared loss of revenue – they were getting less rupees for their dollars. And as the dollar continued to fall, banks started wooing clients via e-mails, even sending company executives on free holiday trips to Singapore, Thailand and South Africa to convince them to buy these derivatives.
DNA has access to several such e-mails and documents which show how banks brazenly violated RBI guidelines.

In 2006 and 2007, under the pretext of a conference, ABN Amro took executives on a free five-day tour of Thailand and Malaysia. “The conference was attended by about 100 such representatives of several companies from India where they were explained about derivative (exotic) products,” as per an affidavit by I Venkateswarlu, executive with Tiruppur-based Armstrong Knitting Mill. DNA has reviewed the affidavit.Subsequently, he bought these derivatives in 2007, which led to a loss of Rs27 crore.
S Dhananjayan, a chartered accountant from Tiruppur, said two of India’s biggest banks took their clients on a fully-paid trip to Cape Town, South Africa, Singapore and other places.
Some banks even put up hoardings in Tiruppur emblazoned: “Suffering from forex losses? Come to us, we have a solution”, while others preferred to draw customers by sending personalised e-mails and attractive presentations.
Banks’ particular interest in Tiruppur companies can be attributed to the fact that Tiruppur is a leading source of hosiery, knitted garments, casual wear and sportswear exports for India, and therefore, a major source of foreign exchange for the country. The city accounts for 80% of India’s cotton knitwear export, worth an estimated US$2 bn. Besides Tiruppur, exporters in Mumbai, Hyderabad, Ahmedabad and a few other cities were also targeted by the banks to sell exotic derivatives.
Early 2007, Rajith Kumar Naidu of State Bank of India, Chennai, sent an e-mail to a Tiruppur-based exporter saying, “Please find attached some very interesting structures with potential to earn huge profits… Please call me for further clarification.” In the next e-mail, Naidu claimed that these derivatives have “strong possibility of making profits”.
Further, banks used a template of contracts to avoid procedural delays and finalise the deals quickly. For instance, ICICI Bank signed a contract which was meant for a company with a Tiruppur-based partnership firm to quickly set the process rolling. In many cases, even the important sections of the contract agreement were left blank. DNA accessed many copies of such contracts.
The other strategy that banks followed was holding exclusive seminars on how derivatives are an easy option of making profits and offsetting losses due to fluctuating forex rate, said Dhananjayan.
The RBI guidelines said banks should carry out due diligence to ensure that each derivative transaction is suitable and appropriate to a customer’s requirements.
However, none of these banks followed it in principle, and encouraged corporates to sign deals that were purely speculative in nature and, without a doubt, inappropriate for the business.
In this regard, the RBI had written a letter to CBI on October 27, 2009, listing 10 rules, under the Foreign Exchange Management Act and RBI, which these banks flouted while selling derivatives during 2007-08.
Since the deals were formed without underlying assets, as soon as the issue was highlighted in media, banks made traders sign some underlying papers to cover up the fraud.For example, one R Senthilvel of ABN Amro, sent an e-mail on November 7, 2008, to Cylwin Knit Fashions of Tiruppur, saying “Take printouts of the attached (an order sheet document of an unknown trader) and affix a seal of Cylwin and sign and give to us.”
However, the order sheets were not pertaining to Cylwin at all.
If that were not enough, banks forced and intimidated exporters to sign documents at the end of the financial year 2009 in a rush to convert derivative losses into corporate loans.“In fact, in one exporter’s case, the documents converting the loss into a loan were signed at midnight on March 31, 2009,” said Raja Shanmugam, president of Forex Derivative Consumer Forum.
In 2009, the central bank directed all the banks to maintain a separate account for losses due to exotic derivatives, yet many banks didn’t.
DNA is in possession of many letters exchanged between SBI and exporters, where exporters appealed to Tiruppur branch of SBI to implement the RBI direction, but the largest public sector bank did not. The matter has been pending with the Supreme Court for more than two years now.

Forex derivatives a bigger scam than 2G

Nineteen banks, which violated the RBI and FEMA guidelines to sell forex derivatives to exporters in 2008, caused a monstrous loss of Rs 25 lakh crore

Bibhuti Pati Bhubaneswar

IT’S A scam with an estimated value of approximately Rs 25 lakh crore, much bigger than the 2G scam that rocked the country in 2010. Nineteen banks, which violated the Reserve Bank of India (RBI) and Foreign Exchange Management Act (FEMA) guidelines to advise and sell forex derivatives to Indian exporters in 2008, resulting in humongous losses to them, have been penalised by the RBI negligible amounts ranging from Rs 5 lakh to Rs 15 lakh each. Several other countries have also faced major economic crises in recent times, as a result of volatility due to similar derivative contracts. Even Barack Obama has noted that unregulated derivative contracts are the main cause of recent financial crises. In the Indian context, the RBI has stated that the losses sustained by customers do not amount to gain by the banks as a result of such derivatives. The question then is — who stands to gain from derivatives during volatility in the money market?

Amidst the dying embers of the 2G scam, and the sparks flying from the anti-corruption movement led by Anna Hazare, however, there is one scam that has somehow got buried.

The RBI recently investigated violations of FEMA by 19 banks. The immediate victims of these violations were importers, exporters and firms selling foreign exchange derivative contracts, resulting in massive losses due mainly to fluctuations in the value of the dollar. What has recently come to light is that the RBI itself had not vetted any of the contracts that were sold, a fact it has admitted. A few of the erring banks have been penalised relatively negligible amounts of Rs 5-15 lakh. “The scam is estimated to be valued at approximately Rs 25 lakh crore, much bigger than the 2G scam,” says Orissa High Court advocate Manoj Mishra.

As per the CBI affidavit in the Orissa High Court, “The RBI has been monitoring the gross mark-to-market (end-to-end) losses incurred by the banks. As on December 2008, the gross mark-to-market gains (that correspond to losses incurred by consumers) of 22 banks that were in the business of derivatives work out to Rs 31.719 crore,” says RP Luthra, advocate, Delhi High Court.

This figure, however, is contested by Pravajan Patra, an eminent economist, in a PIL filed in the Orissa High Court. His contention is that the total value of derivative contracts sold in India and approved by the RBI is $3 trillion, based on the statement of the then finance minister P Chidambaram in the Rajya Sabha. Compare this to the total GDP of India, which is not more than $1 trillion, or its total export and import (including oil bills), that do not exceed $500 billion a year on average. The fluctuation in the value of the dollar during the period in question in 2008, however, was Rs 8.50-10. If this difference is multiplied by even the (conservative) estimate proposed by Chidambaram, that of $3 trillion, we end up with a loss in excess of Rs 25 lakh crore. Compare this to the estimated loss incurred by the exchequer in the 2G scam — Rs 1.76 lakh crore. Peanuts.

Based on the PIL, the Orissa High Court ordered a CBI investigation into these missing funds. The court directed the CBI to hold a preliminary inquiry. Instead, the CBI just sent a questionnaire to the RBI and investigated the president of a forex derivative consumer forum, mere eyewash as opposed to the inquiry that was required.

In addition to this, the 19 banks which violated RBI and FEMA guidelines have paid a negligible penalty. The RBI penalised the banks in its order of April 19, 2011 for violations of its guidelines under the Banking Regulations Act, 1949, and found the banks guilty on various counts, ranging from failure to carry out due diligence with regards to suitability of products, to selling derivative products to users without risk management policies, for not verifying the adequacy of underlying and eligible limits under the past-performance clause. Then in August 2011, the RBI, in response to an rti filed by Delhi lawyer Karan Jain, admitted that the banks had flouted FEMA and RBI guidelines.

But how did 19 major banks manage to violate FEMA rules simultaneously and with impunity, without being in conjunction with a larger purpose? With the very economy of the country at stake, could this monetary crisis possibly have been generated to siphon off significant amounts of money abroad? Where this money has gone can only be a matter of speculation, and leaves one to believe that there is, indeed, a larger conspiracy.

Apart from this, a surprising admission by the RBI was that it does not vet all forex derivative products sold by banks in the country, in effect leaving the door open for a repeat of such scandals in the future. A CBI probe is definitely needed to look into how these violations took place, and how exporters, who are the main victims of the scam, can get some reprieve.

What are unregulated derivative contracts?

WHAT, THEN, is a derivative? It is a contract between two parties that specifies conditions under which payments, or payoffs, are to be made between two parties. It is often used to hedge a transaction.

DERIVATIVE DECODED . It is a contract between two parties that specifies conditions under which payments, or payoffs, are to be made between them . At any particular point in time, if the conversion rate is Rs 40 to a dollar, an exporter should get Rs 40 lakh for exporting goods worth $1 lakh . If, by the time the transaction takes place, the value of INR appreciates to Rs 35 per dollar, the exporter, even though his goods were worth $1 lakh, would eventually end up with Rs 35 lakh as payment . Hence, to avoid such loss, exporters are encouraged by banks to enter into a derivative contract

To understand how this works, let us look at an example: We know that when an exporter sells his goods abroad, he transacts through banks authorised to deal in foreign exchange. Let us suppose that for a particular exporter in a particular transaction, the export is worth $1 lakh in the US. The exporter expects to get back an amount in Indian rupee (INR) corresponding to the conversion rate prevailing at that time.

Let us now suppose that at any particular point in time, the conversion rate is Rs 40 to a dollar. The said exporter should get Rs 40 lakh for exporting goods worth $1 lakh. If, by the time the transaction takes place, the value of rupee appreciates to Rs 35 per dollar, the exporter, even though his goods were worth $1 lakh, would eventually end up with Rs 35 lakh as payment, effectively losing Rs 5 lakh during the transaction due to volatility in the exchange rate. To avoid such loss, exporters are encouraged by banks to enter into a contract whereby the exchange rate is insured or sealed at a particular level, so that even if there is an unexpected fall in the rate, the exporter would not suffer big losses. Therefore, when the market is volatile and the rupee appreciates alarmingly against the dollar (that is, the net return in rupee against the dollar falls), the exporter sustains no loss if his product value is secured/insured by the derivative contract. On the other hand, if rupee depreciates (that is, the net return in rupee against the dollar rises), the exporter sustains a loss, as due to the same contract, he would get less amount than the actual conversion value. Thus the derivative, in this case, protects against rupee appreciation, but not against depreciation.

The Derivative Regulations of 2000 issued by RBI and FEMA regulations detail procedures for regulating such derivative transactions. As it turns out, they were clearly flouted in 2008.

It can now be understood as to why exporters and corporate houses, apprehensive of future appreciation of the rupee that would lead to huge losses, and being misinformed and misdirected by the banks, would enter into long-term derivative contracts.

This is exactly what happened. In 2008, the price of steel skyrocketed, and as a result, the construction industry was heavily affected. At this time, the value of rupee against the US dollar started appreciating alarmingly, from Rs 39-40 in January-February.

Taking advantage of the volatile situation, unscrupulous foreign exchange traders like foreign banks and some leading Indian banks tried to project in the electronic and print media that in the near future, the rupee would further appreciate, and may soon reach Rs 30 to the dollar or less.

Exporters, including corporate houses, lured by such publicity and fearful of losses, started entering into derivative contracts with banks that had long-term tenure and exposure much beyond this limit.

As is often the case, the government never allows such appreciation to go on unchecked, beyond a point. So, in reality, the situation started improving as the Indian government started taking steps shortly after the initial scare in 2008, and the rupee started depreciating against the dollar.

But, fed by scare stories, exporters and corporate had by that time, already entered into derivative contracts with banks, and ended up incurring huge losses. Many small exporters closed down, while shareholders and investors in big corporate houses also sustained huge losses.

This loss incurred by investors/importers/exporters, based on what they thought was reliable information by the RBI, is nothing short of fraud, influenced by a conspiracy of bankers and other unknown co-conspirators.

But who gained? The banks selling derivatives say that they are only agents and get a commission in each transaction.

It is important to note here that whenever a derivative contract is executed for a particular amount, there is a back-to-back contract with another bank in India or abroad. They are called counter parties. The difference goes to counter parties as service charges, at the cost of investors/exporters in India. The RBI clearly admitted that there are large-scale violations of FEMA by banks while dealing with derivative contracts. As has been noted earlier, the RBI admits that due to such actions, the loss sustained by customers do not amount to gain by the bank. It is however not so forthright about the counter parties, the actual gainers, in this case mostly banks based abroad. Could there also have been a concerted effort between these counter parties and the 19 Indian banks to coerce Indian exporters and corporate to jump into these derivative contracts? The way events panned out, it certainly suggest so.

Moreover, what was the role of the Indian media? Were they also knowingly involved in doing so? In light of the Press Council of India report in 2010 that found a significant section of the media indulging in publishing paid stories, nothing seems impossible in the brave new India.

Did india’s banks fulfill their fiduciary responsibilities?

FIDUCIARY responsibilities are the responsibility of a bank to act in the best interests of the depositors. An association of scheduled commercial banks, public financial institutions, primary dealers and insurance companies that represents the interests of the banks allegedly sold illegal forex derivative products to small and medium scale enterprises (SMEs) in dereliction of such responsibilities. The Orissa High Court passed a path-breaking judgment on this issue, in the case of Nahar Industries vs Axis Bank, stating that these cases could not be referred to the Debt Recovery Tribunal (DRT) of India, and should be heard only by the local court having jurisdiction in the matter. It is also hearing the petition filed by the Fixed Income Money Market and Derivatives Association of India (FIMMDA), asking for an RBI inquiry in the case.

IRRESPONSIBLE RBI . According to the RBI and CBI’s own submissions, there have been massive violations of FEMA and RBI guidelines . Till now, no remedial action has been taken by the RBI and the government to mitigate the situation . With the dollar falling again due to inflow of hot money into the stock markets, it is time that government initiated some policies to protect industry from the negative impact of such temporary inflows

Some larger corporates with huge working capital and separate treasury cells may find derivatives useful (even though companies like Wockhardt in India, and many others abroad have suffered unimaginable losses) but in general, are these products then really of much use in generating competitive advantage for corporates? Do they really help them to operate more efficiently? Products like these are being wrongfully sold to SMEs in particular in India, causing huge problems in industries like textile, pharma. Is it proper to allow sales of such sophisticated and high-risk instruments to SMEs with smaller working capital, jeopardising hundreds of thousands of jobs? Larger questions on the fiduciary responsibility of banks, on allowing leveraged derivatives with unlimited downside to be sold in the country, arise. There are ample examples of banks and countries going down due to ill-advised use of derivative products in the West. Is our country in general and SMEs in particular suitable for sale of such products?

Banks, the world over, are under scrutiny for their role in recklessly using various derivative products to precipitate crises and profit from it. Recent examples would be the sub-prime crisis in the US that brought the global economy to the brink of collapse, as also the Greek solvency crisis, where credit default swaps (CDSs) were used to profit from the rescue efforts to stabilise and salvage the Greek economy. Is unfettered sale and use of derivative products desirable? In the US and the EU where, incidentally, speculation is legal, lawmakers are bringing about legislations to prevent such incidents from happening in the future.’

In India, where speculation, especially in foreign exchange, is illegal, and where, according to the RBI and CBI’s own submissions, there have been massive violations of FEMA and RBI guidelines, there has been no remedial action by the RBI and the government to mitigate the situation. Is the well-being of small and medium scale corporates, and the citizens employed in such enterprises, not a matter of concern for the government? Why is it that three years since this crisis broke, a year since the interdepartmental group (IDG) of the RBI made its submissions and findings, no action has been taken to ameliorate the condition of the affected parties?

With the dollar falling again due to inflow of hot money into the stock markets, isn’t it time that government of India initiated some policy measures to protect industry from the huge negative impact of such temporary inflows? Many countries have initiated policy measures, including taxing such inflows, amongst others, to reduce the attractiveness to speculators, and to encourage long-term investment in the country. What is the Indian government doing?

32,000 crore banking scam, RBI caught unawares : SPECIAL STORY

Special Story / Niranjalli Varma

New Delhi: India is celebrating the season of scams as the biggest ever corruption cases were unearthed more recently. Though most of us come across some kind of corruption in our everyday lives, every reader’s eye, popped out, each time they heard the humungous figures, attached with each scam, be it the 2G spectrum scam, the Commonwealth game scam, Aadarsh housing scam or the Sathyam scam.

We came out in the open and screamed enough is enough. The corrupt politicians and multinationals had tested our patience. We also expressed our solidarity towards the timely entry of the anti corruption crusader Anna Hazare. Though the 2G scam successfully cast its bewitching spell on the media and fed the starving  press and readers, the brewing Rs 32,000 crore banking scam remained buried and failed to attract much media attention.

In a profit craving frenzy the banks have managed to demolish all legal and financial barriers. This shocking news comes at a time when India has been basking in the glory of all the praises showered upon her by the developed nations of the world. Even when US and every developed country of the world were facing the second depression or the financial recession of all times, RBI was lauded for its exemplary services and stringent rules. The common man and investors felt safe in the hands of our banks.

It is this trust that has been breached. Banks have managed to violate the extant rules as a result of which gullible importers, exporters and other companies were sold foreign exchange derivative contracts in 2008 resulting in massive losses. The banks seem to have violated not only the apex banks guidelines themselves but also the FEMA Act. Exporters have alleged that the member banks of Fixed Income Money Market Derivatives Association of India (Fimmda) , by violating RBI and FEMA guidelines, issued derivatives and caused them losses of more than  Rs 32,000 crore.

Derivatives are complex business contracts that aim to minimize or hedge investment risks. They can also be used for making money through speculation. Some of the common derivative instruments include futures contracts, forward contracts, options and swaps and involve assets like stocks, bonds, commodities, currencies, interest rates and market indices. An Orissa based businessman, Pravanjan Patra, filed a writ petition in the High Court of Cuttack, Orissa alleging that banks have induced the exporters to engage into forward contracts that resulted into loss of thousands of crore of rupees.

Acting on a petition filed by Pravanjan Patra, the High Court had on December 24, 2009, directed a CBI probe into the alleged sale of forex derivatives to exporters in gross violation of foreign currency laws of RBI and FEMA. The petitioner alleged that the banks induced the corporate houses to enter into derivatives to the extent of six times the normal or required limit thus violating the RBI guidelines.

The Fixed Income Money Market Derivatives Association of India (FIMMDA) however, challenged the High Courts directive on CBI inquiry before the Supreme Court. The Supreme Court had directed some exporters, who requested that they be made a party in the case, to file their replies, which was later referred to the registrar of the apex court for verification.

In June 2010, Forex Derivatives Consumers Forum, who had suffered losses as a result of the alleged scam by banks and lenders owing allegiance to FIMMDA had approached the apex court requesting that they too be made a party in the case. They had requested the apex court to allow a CBI inquiry into the scam by lifting a stay on High Court order.

The Central Bureau of Investigation (CBI), the nodal investigating agency of the Union Government after preliminary investigations  stated that the banks and exporters have violated the guidelines of FEMA. In a submission to the Orissa High Court, the agency said that the banks and corporates have used the hedging tools as profit making tools. “Violation of guidelines were committed by  banks and exporters, who in many cases entered into derivative contracts far in excess of their genuine underlying exposure and also tried to use the hedging tools as profit making tools.

“If the guidelines had been adhered to, the losses would have been contained, especially in such instances where the cost of reducing strategies led to increase in risk profile or where contracts far in excess of the genuine underlying exposures were made”, it further added. However, CBI in its reply filed before the apex court did say that some of the allegations raised against the banks were found to be false and that it was a “herculean task” for them to probe the entire matter. It suggested in its reply that such a probe should be conducted by the ED and RBI.

The RBI clarified that FEMA does not prescribe a ceiling on the total of derivative contracts that can be entered into by the country as a whole. However, the central bank has also specifically pointed out that a number of exporters went in for hedging far in excess of their genuine underlying assets or without any underlying assets in violations of the guidelines for which the exporters as well as concerned banks are liable.

Hedging is a risk management tool, but exporters tried to use it as a profit management tools. This has resulted into multiplication of losses suffered by them when the movement of currencies involvement went in a direction opposite to that envisaged by them.

The Reserve Bank of India has accepted that some of the products especially for the cross currency derivative products violated the provisions of FEMA and regulations made there under. “As regard the counter parties for them clients, the counter parties were the concerned banks, whereas for the banks, the counter parties were other Indian/ foreign banks,” it added.

What is pertinent to note is that the RBI itself has not vetted any of the contracts that were sold. Another interesting fact is that for this scam that is estimated to value approximately Rs 32,000 crore some of the erring banks have been penalized negligible amounts ranging from Rs 5 to Rs 15 lakh.

From the information brought out with the aid of the RTI act filed by Mr Karan , we are informed that the RBI claims to have taken action against the banks based on the report of the Annual Financial Inspection which was conducted under Section 35 of the Banking Regulation Act of 1949.

The RBI has imposed penalties under Section 47A (1) (b) read with Section 46(4)(i) of the Banking regulation Act for contravention of various instructions issued by the Reserve Bank in respect to derivatives. The RBI has imposed penalties under Section 47A (1) (b) read with Section 46(4)(i) of the Banking regulation Act for contravention of various instructions issued by the Reserve Bank in respect to derivatives.

The Apex controlling body of all banks has easily washed its hands of the entire incident. According to them it was solely the responsibility of the banks to vet the legality of the products that they were selling thereby raising a very important issue of whether a central regulatory body is the way forward in this industry.

Surprisingly the RBI has no idea what the penal provisions under the India legal system are for illegally selling derivative products. They even are clueless as to who is responsible for their enforcement. The case is still under trial. How and when justice will be meted out is yet unknown.

FIMMDA vs. Pravanjan Patra and FOREX FORUM case in Apex Court on January 23

New Delhi/ Tiruppur, January 22, 2012
The case filed by the Fixed Income Money Markets and Derivatives Association (FIMMDA) to stall

the CBI probe ordered by the Hon’ble Orissa High Court against 22 erring banks in the forex derivatives transactions of 2007-08 is slated for hearing in the Hon’ble Supreme Court of India on January 23, 2012 as per the latest Advance Cause list published in the Hon’ble Supreme Court of India website.

The impleadment petition of the Forex Derivatives Consumers Forum comprising of exporters from across the  country who were sold the ‘exotic’ derivative products by banks along with the final hearings on the case are expected to come up for hearing before the SC bench on the said date.

“The final hearing and arguments of the counsel of the impleaded parties are expected to be heard during this hearing which incidentally is on a non-miscellaneous day.

We therefore expect substantial arguments to be presented re the case details something that has not happened in earlier hearings on the matter. ” apprises S Dhananjayan, Chartered Accountant and Advisor to the Forex Derivatives Consumers’ Forum. “We hope to see the beginning of the end of this heinous white collar crime committed, as per the CBI and RBI, through flagrant violation of the extant FEMA act and RBI guidelines, on the small and gullible exporters of the country.” It may be noted that the Hon’ble Orissa High Court had passed a judgment on Dec 24, 2009 in response to a PIL filed by an economist, Pravanjan Patra, ordering a CBI enquiry against 22 banks who were involved in selling exotic forex derivative products to exporters in 2007-2008.

“In a preliminary report to the court, CBI had gathered data from the Reserve Bank of India that 11 banks had unrealized dues from customers of Rs 755.45 crore between April 2007 and December 2008, while the gross mark-to-market (revaluing assets at their current values) losses of the customers of 22 banks were Rs 31,719 crore between 2006 and 2008,” informs Dhananjayan.

 Further to the same, the FIMMDA had approached the Hon’ble Supreme Court in Feb 2010 urging a stay on the CBI probe. The Apex Court had ordered an interim stay on the probe. Subsequently there have been several hearings.

 The interim stay ordered by the Apex Court continues till the next hearing, which is now coming up on January 23, 2012. says press release.

RBI asks banks to secure approval from cos issuing derivatives

November 02, 2011

Mumbai: The Reserve Bank Wednesday asked banks to seek approval from company boards before selling derivative products to them.
 
“Before offering any derivative product to clients, banks should obtain board resolution from the corporate which explicitly mentions the limit assigned by the corporate to the bank,” the Reserve Bank said in a notification modifying the ‘Comprehensive Guidelines of Derivatives’.
 
The direction assumes significance in the light of allegations from certain quarters of mis-selling of derivative products by banks resulting losses to investors during the 2008-09 global economic crisis.
     
The board resolution has to mention the names and designation of officials of the company authorised to undertake particular derivative transactions on behalf of the company and specify the names of the people to whom transactions should be reported by the bank.
 
Banks sell derivatives to help companies to hedge risks against fluctuations in foreign exchange value and interest rates, and earn a fee.
 
Banks have also been directed to ensure that there is mention of the names and designation of persons authorised to sign the International Swaps and Derivatives Association (ISDA) and similar agreements and also of specific products that can be transacted by the designated officials.
     
“It should be ensured that the Board resolution submitted by the company is signed by a person other than the persons authorised to undertake the transactions,” the notification said.
     
RBI had in April this year imposed a fine of Rs 1.95 crore on 19 banks, including leading lenders like SBI, HDFC Bank, ICICI Bank and Citibank, for violating regulations concerning derivatives.
     
The lenders had been charged with failure to carry out due diligence with regard to suitability of products and sold derivative products to companies not having risk management policies. They also failed to verify the adequacy of eligible limits before selling derivatives.

PTI

Banks violated FEMA in derivatives trading, says RBI

Partha Sinha, TNN

MUMBAI: In the last six months, the Reserve Bank of India (RBI) has penalized 20 banks for violations of its directives on derivatives contracts, and the banks got away with fines between Rs 5 lakh and Rs 15 lakh. The RBI releases mention that the penalties were imposed for contravention of various instructions issued by the regulator in respect of derivatives, like failure to carry out due diligence in regard to suitability of products, selling derivative products to users not having risk management policies among others. Now a reply from RBI to an RTI application by a Delhi-based lawyer has shown that some of the banks had also violated Foreign Exchange Management Act (FEMA), which is a criminal offence.

In its RTI reply to Karan Jain, a lawyer at Delhi high court, RBI said that “compliance function in certain banks had failed to ensure strict observance of the provisions of FEMA.” However, the banking regulator declined to share with the RTI applicant its findings of inspections of banks’ on the ground that such findings were “confidential in nature” and “disclosure of which would prejudicially affect the economic interests of the state and harm the bank’s competitive position”.

With RBI now admitting that the FEMA was violated, Jain, the RTI applicant, expects the authorities to move against banks for such criminal violations. “Whose responsibility is it to enforce FEMA?,” Jain asked. “Admittedly, the losses from these contracts are losses to the economy. So is it not for ED ( Enforcement Directorate) to take suo motu cognizance of the FEMA violations?” he asked.

The cases relate to 2007 and 2008 when several banks were selling foreign exchange derivative contracts to corporates, several of which were sold projecting profits for the buyers on the assumptions that certain currencies will move favourably. However, as some of the major currencies like Swiss Franc showed unusual movement, a large number of corporates lost money. Subsequently, while several court cases were fought between the companies and the banks, a public interest litigation (PIL) in the Orissa high court ordered that CBI should investigate the whole matter. The HC order was then challenged by the national body of the foreign exchange dealers in the Supreme Court, saying that the appropriate investigating authority in this case is the RBI and not the CBI.

The apex court is yet to rule on whether CBI or RBI should investigate the alleged violations of forex derivatives rules by banks, and the next hearing is slotted for September 27.

On Friday, RBI fined two banks__Credit Agricole and Karnataka Bank__for violations of its directives for banks while dealing in derivatives contracts. The two banks joins another 18, which include biggies like SBI, HDFC Bank, ICICI Bank, Citibank, Standard Chartered Bank and HSBC, that were fined for similar violations in April this year. The fines ranged between Rs 5 lakh and Rs 15 lakh. While the RBI release on the penalties mention that these banks had violated derivatives-related rules and directives, but the same did not mention FEMA violations by these banks. This could be because while RBI is empowered to take action against banks under banking regulations and some other rules. The banking regulator, however, can not take any action against banks under FEMA, said Dhananjayan, advisor to Forex Derivatives Consumers’ Forum, a group of exporters in Tamil Nadu who suffered huge losses after buying forex derivatives contracts from banks and is one of the parties in the Supreme Court case.

Interview on FOREX DERIVATIVES

Dhananjayan, Advisor to the Forex Derivatives Consumer Forum, Tirupur

TWB caught up with Mr.Dhananjayan, Advisor to the Forex Derivatives Consumer Forum, Tirupur earlier this week in town and shared some views about banking

Q) Does the imposition of fines on the erring banks by the Reserve Bank of India in the case of the Rs 32,000 crore exotic forex derivatives now bring the issue to a close?

A) Not at all, the imposition of fine on the erring banks only have vindicated the stand of our Forum that bankers have violate all norms of rules, laws and ethics governing the banking business in India.

But this in no way can be construed as bringing the issue to a close as the pitiable exporter who was saddled with crores of rupees in losses due to the mis-sale of illegal derivative products by these banks are still fighting the legal battle against the mighty bankers, though his legal case get added teeth because of this confirmation of illegality by the apex banking body itself.

Q) The RBI has many a times insisted that the exotic forex derivatives contracts did not represent a systemic risk to the country. In light of the fact that the RBI has now levied fines on the banks do you see this as a perceptible change in the stance of the RBI?

A) We don’t find any definition for the term ‘Systemic Risk’ as this is more of a perception than a defined rule. This opinion of the RBI that such a large scale mis-sale of illegal products by some of the premier banking institutions of the country does not constitute systemic risk is not the kind of perception shared by many industry experts across the country.

This kind of defensive stance on the part of the Reserve Bank creates a suspicion that RBI is espousing the interests of the banks and not acting judiciously the way a banking supervisor should act. The recent levy of penalty on the banks itself might be a result of the pressure created by the Supreme Court where all these mal-practices are likely to get highlighted.

Q) Do you believe that the RBI is sending out a strong signal to erring banks by releasing the report findings and imposing fines on them in advance of the impending hearing of the Hon Supreme Court? Do you believe that this shall prevent and pre-empt such things from happening in the future?

A) No way; On the contrary, we suspect that this levy of fine at this point in time may be a strategy to protect the possibility of banks being subjected to CBI probe by stating before the Supreme Court that RBI has already taken action on the erring bank and no further investigation by CBI is necessary.

Q) Do you think or expect RBI to share/submit its investigation report with Supreme Court?

A) No, we don’t think so –we think that argument that since RBI has already penalized the erring banks, and the civil disputes on the legality of the contracts are already pending at various judicial forums, there is no need for any CBI probe against the banks concerned – will be put forth before the Supreme Court to protect the banks from the risk of facing CBI probe on alleged FEMA violations.

Q) Do you expect any action from the government in this case?

A ) No, the government has already washed off its hands on the ground that the matter is Subjudice.

Q) You have mentioned previously that similar cases of deliberate mis-selling were experienced by exporters in other parts of the world. What action has been taken by courts or regulatory authorities to remedy the situation there? Can you highlight a few specific instances?

A) Similar instances of mis-sale have happened across the globe and the world loss on account of these illegal derivative contracts is pegged at USD 550 Billion. Legal disputes are taking place across the globe in several countries including Germany, Korea, Brazil, Srilanka, Indonesia, etc.

In Germany, the Supreme Court of that country has already held that these kind of contracts are illegal and void contracts under the contract law provisions.

Q) Have any of the banks approached exporters to settle forex derivative issue out of court after RBI fined 19 banks and if yes, why do you think these banks are doing so?

A) Many banks approached the exporters even after the fine by RBI. In our opinion, this may be a result of their legal opinion that their case has gone weaker and weaker every day because of several developments and evidences including the CBI’s and RBI’s report before Orissa High Court, the order of Orissa HC and also the recent slapping of fine by RBI.

Q) What are your expectations from the Hon Supreme Court of India when they meet to hear the case in September?

A) We expect that the Hon’ble Supreme Court of India will look beyond the perceptions and see the reality of the damage caused to small industrialists on account of this grossly illegal acts on the part of the RBI. Also we expect that the Supreme Court will understand that there is more to this iceberg than the tip and order a thorough investigation to be carried out by the apex investigative agency of the country namely the CBI.

Penalty corner

RBI penalises top banks that sold exotic forex products

Subramanian Dhananjayan, a chartered accountant in Tirupur, Tamil Nadu, had a busy second half of April, advising members of the Forex Derivatives Consumers’ Forum from all over the country. The forum had been first set up by small companies based in Tirupur, who had bought exotic derivative products in 2007 from different banks and were trapped in the not-so-fine print of the complex products they never understood.

Renowned for its hosiery and knitwear products, which it exports across the world. Tirupur is a small town with an unusually high concentration of rich traders. But the ones among them who had bought the forex derivatives suddenly discovered that far from having made any money, they now owed crores to the banks. They also found they were not alone. Entrepreneurs from across the country came clamouring to join the forum, as banks got after them, seeking settlements.

“Now we know why the banks were so keen to settle the disputes,” says Dhananjayan, referring to the April 26 decision of the Reserve Bank of India to levy a penalty on 19 banks for selling such products. The list of banks named by the RBI reads like the who’s who of Indian banking . The RBI said in its press release that the penalties were being levied for “failure to carry out due diligence in regard to suitability of products, selling derivative products to users not having risk management policies and not verifying the adequacy of underlying and eligible limits”.

Forum members have been sufficiently emboldened to say they will file claims for damages. The forex derivative products were essentially contracts signed between the banks and the companies, taking bets on different global currencies like the Swiss franc, the Japanese yen and the euro, without any assessment of the underlying foreign exchange exposure of the buyers’ businesses or their foreign exchangerelated risks, which were mostly US dollar-linked. The products were also sold not as risk management products but as schemes that could add to the profits of the companies. While the first few months brought in some profits, as international currency market trends turned, the contracts started to clock losses. The banks’ losses were limited within the contract. But the buyers’ losses had no limits and quickly ran into crores. In a nightmarish spiral, the banks reported them to the Credit Information Bureau as defaulters, which led interest rates on their existing loans being increased and practically snuffed out their chances of getting future loans.

“We were ignorant and the banks took advantage of us. Luckily, we could organise ourselves,” says Raja Shanmugham, president of the forum, who acknowledges the support of Swadeshi Jagran Manch activist S. Gurumurthy.

E. Palanisamy, an entrepreneur whose company Armstrong Knitting Mills had run up a debt of Rs 27 crore, says banks are now ready to settle for much less. “They were earlier asking me to pay 40 per cent of their claim,” he says. “Now they are asking for 30 per cent only. But after the RBI decision, I will not accept it.”

“Men in suits and ties came to Tirupur from big cities to sell us these products,” he adds. “They have now run away, and local branch officials are trying to find a way to settle.” Meanwhile, following a public interest litigation filed by a Cuttackbased taxation expert, Prabhanjan Patra, the Orissa high court has ordered a Central Bureau of Investigation probe into the forex derivatives. The banks, through their associations like the Fixed Income Money Markets and Derivatives Association of India, and the Indian Banks Association, have appealed against the order in the Supreme Court. The appeal is still pending.

“The banks have lined up the top lawyers of the country,” says Manoj Kumar Mishra, who represents Patra. “But the RBI decision had substantially strengthened our position.” The plight of Tirupur’s traders has also attracted media attention in South Korea, where a similar product called the Kiko wreaked havoc in the nation’s small scale sector. The Kiko – or kick-in kick-out contracts – were suspended by Korean courts in 2009. Over 500 Korean companies had recorded a total loss of $1.2 billion on these contracts till 2008, with many filing for bankruptcy.

Exporters seeks compensation for forex derivatives losses

Buoyed by the decision of Reserve Bank to penalize 19 banks, exporters today stepped up their demand for compensation for the losses incurred on account of mis-selling of exotic financial products like forex derivatives contracts by lenders.

“The RBI’s penal action has vindicated our point that derivatives were mis-sold to exporters, which led to heavy losses to them and banks should now compensate for,” A Sakthivel, President of Tirupur Exports Association said.

Exporters have alleged that the banks by violating RBI and FEMA guidelines, issued derivatives and caused them losses of more than Rs. 32,000 crore. Sakthivel, who was also president of Federation of India Export Organisation, said exporters in Tirupur alone incurred losses to the tune of Rs. 400 crore.

While welcoming the RBI’s action, Forex Derivatives Consumers Forum of Tirupur said: “The RBI decision vindicates our stand and gives a boost to our ongoing fight for a CBI enquiry into the whole issue.”

RBI has imposed maximum penalty to erring banks under the Banking Regulation Act, Forum’s advisor S Dhanajayan said, adding, the association was also contemplating filing damage suits against banks. Derivatives are complex business contracts that aim to minimise or hedge investment risks. They can also be used for making money through speculation.

Some of the common derivative instruments include futures contracts, forward contracts, options and swaps and involve assets like stocks, bonds, commodities, currencies, interest rates and market indexes.

Yesterday, RBI slapped a penalty of Rs. 1.95 crore on 19 banks, including heavyweights SBI, HDFC Bank, ICICI Bank and Citibank, for violating norms on derivatives, an instrument used to hedge financial risks.

One of the cases pertaining to losses incurred on account of derivatives contract is still pending in the Supreme Court.