RBI Extends Forex Risk Reserve Requirement to Banks’ Own Hedging Contracts

The Reserve Bank of India (RBI) has expanded its Foreign Exchange Risk Reserve (FERR) requirement to cover eligible rupee-linked foreign-exchange derivative transactions undertaken by authorised banks for their own accounts, including contracts used to hedge their assets and liabilities. The move, announced on October 12, 2026, broadens a cash-reserve measure introduced days earlier for certain foreign-exchange hedges arranged for customers. Under the requirement, banks must maintain a cash reserve equal to 20% of the notional value of covered contracts, increasing the liquidity cost associated with eligible currency hedging.

The decision is part of a wider effort by the central bank to manage pressure on the Indian rupee amid high oil prices, foreign capital outflows and strong demand for dollars. The RBI has also restricted certain non-deliverable rupee derivative contracts offered to non-residents to hedging purposes, rather than allowing them to be used for speculation. However, the expanded rules have raised operational questions among banks about their precise scope. Reuters reported on October 13 that a source familiar with the RBI’s thinking said the cash-margin requirement was not intended to cover interbank transactions, highlighting the need to distinguish banks’ own eligible hedges from transactions between banks.

Key Takeaways

• Wider FERR coverage: The RBI has extended the 20% Foreign Exchange Risk Reserve requirement to eligible rupee-linked derivative contracts undertaken by authorised banks for their own hedging.
• Liquidity impact: Banks must set aside cash equal to 20% of the notional value of covered contracts, increasing the cost of maintaining those positions.
• Rupee support: The measure is intended to discourage excessive demand for currency protection and help manage pressure on the rupee.
• NDF restrictions: Certain authorised dealers and primary dealers can now offer non-deliverable rupee derivatives to non-residents only for hedging purposes.
• Implementation uncertainty: Banks have sought clarity on how the requirements should be applied, and a source familiar with the RBI’s thinking said interbank transactions were not intended to be covered.
• Potential customer impact: Importers and other businesses seeking dollar hedges could face higher costs or tighter availability, depending on how banks price and implement the rules.
• Part of a wider package: The RBI has also introduced measures involving dollar supplies to state-run oil refiners and tightened other rules governing rupee derivatives.

What Is the RBI’s Foreign Exchange Risk Reserve Requirement?

The Foreign Exchange Risk Reserve is a cash-reserve requirement designed to increase the cost of certain foreign-exchange derivative positions involving the Indian rupee.

Under the initial measure announced on October 10, authorised dealers were required to maintain FERR for covered foreign-exchange derivative contracts involving the rupee that exceeded the equivalent of $2 million in notional value and were undertaken with users to hedge current-account transactions where the user purchased foreign currency against rupees.

The requirement was set at 20% of the notional value of eligible contracts. The RBI subsequently broadened its scope on October 12 to cover eligible rupee-linked foreign-exchange derivative transactions undertaken by authorised banks themselves, including hedges of their own assets and liabilities.

The distinction between the initial and expanded measures is important. The first requirement focused on a specified category of customer hedges. The subsequent change widened the scope to include qualifying transactions undertaken by banks for their own accounts.

The purpose is to make covered foreign-exchange positions more expensive in terms of the cash that must be set aside. By increasing the liquidity cost associated with these contracts, the RBI aims to discourage excessive demand for protection against further rupee weakness.

The reserve requirement does not mean that 20% of the notional amount is automatically a fee paid to the central bank. It is a reserve obligation, and the precise treatment depends on the applicable regulatory directions and operational arrangements.

How the 20% Cash Reserve Works

A foreign-exchange derivative is a financial contract whose value depends on exchange rates. Businesses and financial institutions use such contracts to manage the risk that currency movements will increase their costs or reduce the value of foreign-currency receipts.

The FERR requirement adds a cash-reserve obligation to certain covered contracts. A simple illustration shows how the calculation works.

Notional value of a covered contract	FERR rate	Illustrative reserve amount
$2 million	20%	$400,000
$5 million	20%	$1 million
$10 million	20%	$2 million
$20 million	20%	$4 million

Illustrative calculations only. The initial customer-facing rule specified contracts exceeding the equivalent of $2 million and meeting other eligibility conditions. The table does not establish that every contract at these values is covered under the same conditions.

The notional value is the reference amount used to calculate the size of a derivative contract. It is not necessarily the amount of money exchanged when the contract is entered into.

For example, a company might use a forward contract to lock in an exchange rate for a future dollar payment. The derivative’s notional amount may correspond to the value of the planned payment, even though the company does not immediately pay that entire amount to the bank.

A cash reserve equal to 20% of the covered notional amount can tie up liquidity that might otherwise be used for lending, trading or other operations. The reserve therefore changes the economics of covered contracts even when the underlying currency exposure is legitimate.

Why the RBI Is Tightening Forex Rules

The RBI’s measures come amid pressure on the rupee from several directions, including elevated oil prices, foreign capital outflows and strong demand for dollars.

India imports substantial quantities of crude oil, and higher international oil prices can increase the amount of foreign currency needed by Indian importers. When businesses anticipate future dollar payments, they may buy dollars in advance or use derivative contracts to protect themselves against a weaker rupee.

Such hedging is a normal part of managing international trade. However, a rapid increase in demand for dollar protection can add pressure to the foreign-exchange market, particularly when other sources of dollar supply are limited.

Reuters reported that corporate forward-dollar purchases had reached $77 billion in September, an increase of 80% year over year. The rise illustrated the scale of demand for protection against further rupee weakness.

The RBI’s response seeks to influence the cost and use of these instruments rather than relying exclusively on direct currency-market intervention. By requiring additional cash against eligible positions and limiting the permitted purpose of certain derivatives, the central bank aims to reduce incentives for excessive or speculative activity.

The measures do not remove the underlying economic forces affecting the rupee. Oil prices, capital flows, global interest rates and India’s external financing requirements will continue to influence currency demand.

Why the RBI Has Extended the Rule to Banks’ Own Hedges

Banks undertake foreign-exchange transactions for several reasons, including servicing customers, managing foreign-currency assets and liabilities, and controlling their own exposure to exchange-rate movements.

A bank with foreign-currency assets or liabilities may use derivatives to reduce the risk that exchange-rate changes will affect its balance sheet. These transactions can be part of routine risk management rather than speculative activity.

By extending FERR to eligible bank-owned hedging contracts, the RBI has widened the set of transactions that may attract the reserve obligation. The measure reduces the possibility that the cash requirement applies only to certain customer transactions while leaving qualifying bank hedges outside its scope.

The wider application also means banks must review their own positions and determine which contracts fall under the updated directions. That can require changes to treasury processes, liquidity planning, reporting and internal compliance systems.

However, the scope of the rule must be interpreted carefully. Reuters reported on October 13 that some banks had taken a broad reading of the new directions and were concerned that the cash-margin requirement could extend to interbank transactions. A source familiar with the RBI’s thinking said that interpretation was incorrect and that interbank transactions were not intended to be covered.

This clarification matters because interbank dealings are an important part of how banks manage and transfer currency exposure. If banks misunderstand the rule, they may withdraw quotations or reduce market-making activity unnecessarily while seeking regulatory guidance.

What Are Non-Deliverable Forwards, and Why Has the RBI Restricted Them?

Alongside the FERR expansion, the RBI has tightened rules governing certain non-deliverable rupee derivatives offered to non-resident users.

A non-deliverable forward, or NDF, is a contract that allows participants to manage or take exposure to exchange-rate movements without physically exchanging the underlying currencies. Gains or losses are settled in cash, often in US dollars.

NDFs can be used for legitimate hedging. For example, a business with an actual rupee-related exposure may use a derivative to reduce uncertainty about the exchange rate at a future date.

However, these contracts can also be used to speculate on currency movements. A participant may take a position based on an expectation that the rupee will strengthen or weaken, without needing to exchange the underlying currencies.

Under the updated rules, authorised dealers with banking units in India’s International Financial Services Centre and certain primary dealers can offer rupee-linked non-deliverable derivatives to non-residents only for hedging purposes.

The restriction narrows the permitted use of these products. It is intended to reduce speculative activity that could add to pressure on the rupee, although the effect will depend on how market participants adjust their positions and where they choose to transact.

The rule does not mean that all foreign-exchange derivatives have been banned. Rather, it changes the permitted purpose of specified non-deliverable contracts offered to non-residents.

How the New Rules Could Affect Banks

The expanded reserve requirement increases the amount of liquidity that banks may need to allocate to covered positions. This can affect how they price contracts, choose counterparties and manage their overall foreign-exchange exposure.

Banks may reassess the profitability of certain transactions because the cash reserve has an opportunity cost. Money set aside to meet the requirement cannot be used in the same way as unrestricted liquidity, potentially affecting treasury decisions and internal funding costs.

Lenders may also need to update their systems to identify covered contracts, calculate the required reserve and ensure compliance with the RBI’s directions.

The operational challenge is particularly important because foreign-exchange markets depend on banks providing quotations and facilitating transactions. If banks are uncertain about whether a contract is covered, they may temporarily become more cautious while seeking clarification.

Reuters reported that several bankers were holding back from quoting dollar/rupee forwards because of uncertainty over the scope of the new requirement. The source familiar with the RBI’s thinking said interbank transactions were not intended to be included, but the RBI had not immediately responded to Reuters’ request for comment.

This episode illustrates the difference between a regulation’s intended scope and the way market participants initially interpret it. Clear implementation guidance can help reduce disruption while preserving the policy’s intended effect.

What the Rule Means for Importers and Exporters

The cost and availability of foreign-exchange hedging matter to Indian businesses that trade internationally.

Importers often need dollars to pay for crude oil, electronics, machinery, chemicals and other goods. If the rupee weakens before payment, the same dollar invoice can become more expensive in rupee terms.

A forward contract can reduce this uncertainty by allowing an importer to agree on an exchange rate in advance. The contract does not eliminate every commercial risk, but it can make future payments more predictable.

Exporters face the opposite exposure when they receive payments in foreign currency. A stronger rupee can reduce the rupee value of their export receipts, so some exporters use derivatives to protect their expected earnings.

The expanded FERR requirement could affect customer pricing indirectly if banks incorporate higher liquidity costs into eligible hedging contracts. Some customers may face higher quotations, while others may find that banks apply stricter conditions or prioritise transactions based on their exposure and relationship with the lender.

The actual effect will vary by contract, bank and customer. Not every hedge is automatically subject to the same reserve requirement, and businesses should not assume that the 20% figure applies to every foreign-exchange transaction.

For importers with large dollar requirements, higher hedging costs can add to the financial burden created by elevated commodity prices. Exporters and other businesses will also need to monitor how banks implement the revised rules.

Will the RBI’s Measures Strengthen the Rupee?

The measures are intended to reduce pressure on the rupee by making certain hedging transactions more expensive, limiting the permitted use of selected derivatives and addressing dollar demand from state-run oil refiners.

The currency strengthened by about 1% on October 12 after the RBI announced its package of measures, according to Reuters. The move suggested that investors responded to the central bank’s intervention, although a single day’s exchange-rate movement does not establish the long-term effectiveness of the policy.

Currency markets are influenced by many factors. Higher oil prices can increase India’s dollar demand, while foreign portfolio outflows can reduce the supply of foreign currency entering the domestic market. Changes in US interest rates and global investor appetite for risk can also affect capital flows.

The RBI can influence market conditions through regulation, liquidity management and direct intervention, but it cannot fully control global commodity prices or international investment decisions.

The FERR requirement may discourage some demand for currency protection by increasing its cost. However, companies with genuine foreign-currency obligations still need to manage exchange-rate risk, and some may continue hedging even when costs rise.

The policy’s longer-term impact will depend on the balance between reducing excessive activity and preserving the ability of businesses to manage legitimate exposure.

The Bigger Picture

The RBI’s decision reflects a more interventionist approach to managing pressure on the rupee. Instead of relying only on currency sales or broader monetary policy, the central bank is using the cost and permitted purpose of derivatives to influence demand for foreign-exchange protection.

Extending FERR to banks’ own eligible hedges broadens the reach of the policy, while the NDF restrictions target a different channel through which participants can take positions on the rupee. Together, the measures aim to limit excessive demand and speculation without eliminating legitimate currency risk management. Their effectiveness will depend on implementation, market behaviour and the economic pressures driving dollar demand.

Looking Ahead

Banks will need to establish how the expanded FERR requirement applies to their eligible own-account contracts and adjust their treasury and compliance processes accordingly. The clarification that interbank transactions were not intended to be covered will be important in limiting unnecessary disruption, but market participants will continue to look for clear and consistent regulatory guidance. The effect on forward quotations, hedging costs and trading volumes should become clearer as banks implement the revised rules.

For the rupee, the central question is whether the new restrictions can moderate excessive hedging and speculative demand without materially obstructing legitimate business transactions. Oil prices, capital flows and global interest-rate conditions will remain important influences on the currency. The FERR expansion is one part of the RBI’s response, rather than a guarantee of a sustained rupee recovery.