Indian banks are seeking urgent guidance from the Reserve Bank of India on the new Foreign Exchange Risk Reserve (FERR) mandate. The rule requires lenders to set aside 20% of the value of large derivative contracts as interest-free reserves. This move, aimed at curbing currency volatility, is pressuring bank liquidity and may increase hedging costs for corporate clients.
The Reserve Bank of India has introduced a stricter regime for foreign exchange derivative contracts as part of its strategy to stabilize the rupee. Effective from October 10, 2026, banks are required to maintain an interest-free cash reserve equal to 20% of the notional value of any derivative contract exceeding $2 million that is used for hedging current account transactions. This new buffer, officially termed the Foreign Exchange Risk Reserve, is designed to reduce speculative trading and dampen volatility in the currency market.
While the goal is market stability, the implementation creates immediate operational friction for lenders. Because this 20% reserve earns zero interest, banks face a direct cost for every large hedging contract they manage. When a bank enters into a $3 million derivative contract, which is worth approximately ₹28.7 crore, it must park over ₹5.7 crore with the central bank. This capital is effectively locked up and cannot be used for lending or other income-generating activities, creating a drag on bank liquidity and profitability.
Industry representatives, through the Foreign Exchange Dealers' Association of India, have reached out to the central bank for urgent clarification. The banking sector is primarily concerned about the lack of standardized guidelines on how to handle these costs. Without clear rules on calculation methodologies and cost recovery, there is a risk that banks may apply different surcharges to their clients. This could lead to fragmented pricing for importers and exporters who rely on these derivatives to protect their businesses from currency fluctuations.
This reserve requirement is part of a broader set of measures aimed at curbing currency pressure. The central bank has simultaneously lowered the threshold for derivative transactions that lack an underlying trade exposure from $100 million to $5 million. Additionally, the regulator has prohibited the rebooking of cancelled contracts, which limits the flexibility previously available to market participants. To prevent immediate market disruption, the RBI has also opened a dedicated window to provide dollar liquidity to public sector oil marketing companies, which are large buyers of foreign currency.
For investors and market participants, the next phase will be critical to watch. The primary monitorable will be how banks adjust their fee structures for corporate clients and whether these additional costs impact trading volumes in the forex derivatives segment. The industry is currently waiting for further communication from the regulator regarding standardized reporting and cost-transmission mechanics to ensure that the new regime does not cause unintended paralysis in the currency hedging market.