Mumbai: Reserve Bank of India (RBI) has clarified that the new foreign exchange risk reserve (FERR) will be not be applicable for banks undertaking trades for market-making or assuming proprietary positions. Also, FERR will not be applicable on interest on External Commercial Borrowings (ECBs) or coupons on resident debt instruments held by non-residents, or dividends payable to non-resident investors, the central bank said in FAQs released on Thursday.

The clarifications are a relief to banks who were unsure of trading in the foreign exchange market after the RBI imposed a 20% cash reserve requirement on forex derivative contracts above $2 million. The RBI said that the FERR requirement applies only to derivative contracts where the user purchases foreign currency against rupee.

The FERR applicable for a particular derivative contract is required to be maintained until a day after the termination of the derivative contract. The FERR shall be deposited and maintained in the authorised dealer’s current account with RBI on a daily basis. These funds maintained with the RBI shall not earn any interest and will not be classified as high quality liquid assets (HQLA).

RBI said the new FERR requirement will not apply to foreign exchange derivative contracts undertaken by users for hedging capital account transactions like foreign direct investments, ECBs or issuance or transfer of equity shares.

FERR is applicable for authorised dealers with notional value exceeding $2 million but banks must guard against any attempt towards structuring of derivative transactions for avoidance of these provisions, RBI said. The notional amount of the single option with the highest notional value shall be reckoned for applying the $2 million threshold and computing the FERR.

Upon part cancellation of the derivative contract, if the notional amount of the derivative contract which is still valid falls below the applicable threshold, the FERR requirement for such derivative contracts will cease, from the day following such reduction, RBI said.