What could be common between Barings Bank, Long Term Capital, Berkshire Hathaway and Indian companies such as ICICI bank, Wockhardt and Varun Shipping? All these companies have, in some way or the other, found themselves on the wrong side of derivatives.
Warren Buffet in his letter to the shareholders in 2003 had described derivatives as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” While Buffet’s worst fears appear to have come true in the global corporate arena, its repercussions have begun seeping into the Indian corporate world.
The latest earnings numbers of Indian corporates have brought to fore the marked increase in loss provisioning by banks, mark-to-market losses and forex losses on overseas loans by corporates.
What are these losses and how significant are they? Are the losses recurring or would a one-time provisioning for them suffice? And most importantly, is the worst over or are these losses here to stay? Here are a few takeaways from the trends available so far.
Derivative losses for Indian companies can broadly be classified under three heads:
Forex losses arising out of revenue exposure to foreign currency (hedging direct business exposure or forex denominated overseas loans),
Provisioning of likely losses by banks to cover the risk of non-payment by corporates that have borne huge derivative losses.
Losses provisioned for by banks that have direct exposure to some of the overseas credit derivatives that have notoriously suffered de-rating after the sub-prime rout made its presence felt. Loss provisioning
While there is no mandate at present that requires companies to divulge relevant details about their derivative exposure, we will be getting there soon. The ICAI had recently asked companies to mark-to-market all outstanding derivatives contracts on the balance sheet with effect from FY08 onwards.
Notwithstanding this, ascertaining the exact amount of derivative exposure of companies is difficult. The extent of increase in loss provisioning by banks, however, may offer a few clues. Most of the banks in their March quarter results have provided for losses. This will be used to cover for losses the banks might suffer, if their clients fail to meet their payment obligations on their derivative contracts.
For instance, State Bank of India has provisioned against the forex losses of it clients, which are in the range of Rs 600-700 crore. Kotak Mahindra Bank has provided for over 45 clients with exposure to forex derivatives. Its clients have incurred MTM losses of Rs 612 crore .
To that extent, the mark-to-market provisioning by some of the top Indian banks such as ICICI Bank, SBI, Axis Bank and Kotak Mahindra Bank against their clients’ exposure to various derivative transactions has been pegged at over $175 million (about Rs 700 crore). Mark-to-market losses are arrived at by valuing the derivatives at their prevailing market price.
Warren Buffet in his letter to the shareholders in 2003 had described derivatives as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” While Buffet’s worst fears appear to have come true in the global corporate arena, its repercussions have begun seeping into the Indian corporate world.
The latest earnings numbers of Indian corporates have brought to fore the marked increase in loss provisioning by banks, mark-to-market losses and forex losses on overseas loans by corporates.
What are these losses and how significant are they? Are the losses recurring or would a one-time provisioning for them suffice? And most importantly, is the worst over or are these losses here to stay? Here are a few takeaways from the trends available so far.
Derivative losses for Indian companies can broadly be classified under three heads:
Forex losses arising out of revenue exposure to foreign currency (hedging direct business exposure or forex denominated overseas loans),
Provisioning of likely losses by banks to cover the risk of non-payment by corporates that have borne huge derivative losses.
Losses provisioned for by banks that have direct exposure to some of the overseas credit derivatives that have notoriously suffered de-rating after the sub-prime rout made its presence felt. Loss provisioning
While there is no mandate at present that requires companies to divulge relevant details about their derivative exposure, we will be getting there soon. The ICAI had recently asked companies to mark-to-market all outstanding derivatives contracts on the balance sheet with effect from FY08 onwards.
Notwithstanding this, ascertaining the exact amount of derivative exposure of companies is difficult. The extent of increase in loss provisioning by banks, however, may offer a few clues. Most of the banks in their March quarter results have provided for losses. This will be used to cover for losses the banks might suffer, if their clients fail to meet their payment obligations on their derivative contracts.
For instance, State Bank of India has provisioned against the forex losses of it clients, which are in the range of Rs 600-700 crore. Kotak Mahindra Bank has provided for over 45 clients with exposure to forex derivatives. Its clients have incurred MTM losses of Rs 612 crore .
To that extent, the mark-to-market provisioning by some of the top Indian banks such as ICICI Bank, SBI, Axis Bank and Kotak Mahindra Bank against their clients’ exposure to various derivative transactions has been pegged at over $175 million (about Rs 700 crore). Mark-to-market losses are arrived at by valuing the derivatives at their prevailing market price.
