RBI asks some banks not to take fresh NDF arbitrage bets

August 24, 2023
Posted by: OptimizeIAS Team
Category: DPN Topics

RBI asks some banks not to take fresh NDF arbitrage bets

Subject :Economy

Section: Monetary Policy

In News: Reserve Bank of India (RBI) has asked some banks to stop taking fresh arbitrage positions in the non-deliverable forwards market.

Key Points:

Non-Deliverable Forwards (NDF) are foreign exchange forward contracts traded in the over-the-counter market at offshore destinations (see box for details). These are used to manage currency exposure, especially to currencies that are not fully convertible.
The restrictions are apparently aimed at managing the volatility of the Indian rupee. Similar restrictions were imposed when the rupee hit a record low of 83.29 in October 2022, the RBI had informally asked local banks to not build additional positions in the NDF market. The restrictions were lifted in December once the volatility ebbed.
The rupee reached 83.16 last week and only the RBI’s intervention in both the NDF and onshore markets prevented a slide to the record low.
What are foreign exchange forward contracts?
- The forward market for currencies, often referred to as the “currency forward market,” is a financial marketplace where participants can enter into contracts to exchange one currency for another at a specified future date and at a predetermined exchange rate.
- Forward contracts are a type of derivative that allows businesses and investors to manage their currency risk and lock in a future exchange rate.
What are arbitrage positions?
- Arbitrage positions are trading strategies that take advantage of price discrepancies between related financial instruments or markets to generate profit with minimal risk.
- The goal of arbitrage is to exploit temporary price imbalances that exist due to market inefficiencies.

Non-Deliverable Forwards (NDF)

These are foreign exchange forward contracts traded in the over-the-counter market at offshore destinations, generally major international financial centres (Can now be traded in IFSC banking units).
An NDF contract is similar to a regular forward foreign exchange contract but does not need physical delivery of currencies at the time of maturity.
In fact, NDF contract is typically cash settled in international currency on a specified future date. Since the NDF market operates in overseas financial centres, it remains outside the regulatory purview of the local authorities.
An NDF market generally grows when the onshore forward market is either under-developed or its access for market participants is restricted.
NDF markets allow market agents, facing regulatory restrictions in the onshore market, to hedge their exposures and speculators to take a position on future movements in domestic currency. In fact, as market players’ interest grows in a particular currency with convertible restrictions