KARACHI, Sept 18: The State Bank has started giving approvals for derivative-specific proposals for hedging against interest rate risks on the basis of a case-by-case scrutiny.
Sources here said only limited cases, submitted by the banks are processed by the central bank to satisfy itself that the corporates are fully aware of the risk in derivative products which translates into “the gain of one is the loss of the other.” Foreign banks have acquired expertise in foreign derivative markets but local corporates need to be made aware of the downside or the risks in the hedging business, says a banker.
Apparently, financial analysts said, the State Bank may find it easier to approve proposals that come from multinationals and foreign banks which have been exposed to derivative markets worldwide. It may be a little tricky in case of strong domestic banks and local corporations. Initially, smaller banks and the bulk of the local firms may have to be kept out.
Country representative of the ABN-Amro Naved Khan told Dawn that proposals are approved by the State Bank within 48 hours.
Incidentally, multinationals prefer to do business with foreign banks. A local bank official said a case or two are believed to have been rejected on lack of adequate information.
Sources here said the central bank is moving cautiously because it does not want hedging against loan risks to degenerate into a speculative business and to build up its own capacity to monitor effectively the derivative market as it gradually evolves. There is need to learn from experience, says a financial analyst.
The key issue is to make businesses aware of the hedging risks. On the advice of the State Bank, Habib Bank’s treasury and corporate divisions jointly organized a presentation on Wednesday to introduce their customers to a variety of interest rates and foreign exchange derivative instruments and products. These included forward rates agreements (FRA), interest rate swaps (IRS) and currency options.
HBL officials explained that FRAs are simple interest rate derivatives that enable a corporate to hedge itself against future fluctuations of interest rates. IRS are agreements between the two parties to exchange streams of interest payments: one of which is fixed and the other floating. Options are the right but not an obligation to buy or sell an underlying asset such as currencies and equity, at a predetermined price at a future date.
However, State Bank Governor Dr Ishrat Husain told a seminar, organized by Pakistan Bank Association recently on “Derivatives — the way forward,” that “we have to start with interest rate swaps. For the regulators, to make a distinction between a true hedging against risk and speculation is going to be a big challenge.”
Financial analysts say that there is a tendency of the people to become multi-millionaire overnight and speculation in derivative markets often plays havoc with economies.
A task force (TF) comprising representatives of Pakistan Banking Association and Financial Market Association has been set up to make recommendations to the central bank on how to develop the derivative market. After discussions of the initial TF reports, the State Bank has asked the task force to re-examine legal, tax and accounting issues.