What went wrong?
IndusInd Bank has reported discrepancies in its derivatives portfolio related to transactions spanning the last 7-8 years. These issues arose from internal trades involving low-liquidity instruments, such as 3-6-year yen and 8 to 10-year dollar borrowings.
The bank entered into these internal trades specifically for instruments with limited liquidity in the external market. Instead of directly hedging foreign currency borrowings and deposits with external counterparties, the bank used its internal desk for the hedging process.
While external trades were marked to market, internal trades were valued using swap valuations. As a result, the two legs of the trade could fluctuate during the contract period but would typically converge at maturity. This practice had been ongoing for past 5-7 years.
A swap is a derivative contract in which two parties exchange cash flows or liabilities from different financial instruments.
How was the discrepancy revealed?
After a new RBI circular was issued in September 2023, the bank began reviewing its derivatives portfolio, which led to identification of these discrepancies.The bank was repaying certain foreign currency borrowings where internal trades had been unwound. During this process, the bank discovered that in some cases, one of the trades was impacting the P&L, while the other was affecting the asset book.
What did the bank do?
All internal trades since April 1, 2024, have been unwound and the bank no longer holds any unhedged positions.
The bank has now shifted to external trades with counterparties. All foreign currency borrowings converted to INR are fully hedged based on their tenor, ensuring no exposure on the balance sheet.
The bank has engaged an external agency for an independent review and validation. It has notified RBI and is conducting an external audit to identify the source of the discrepancies.
What is the financial impact?
The internal review estimated an impact of 2.35% of net worth, approximately ₹1,600 crore. This financial impact will be absorbed as a one-time charge in the March quarter, recorded through the P&L statement. The final amount may vary slightly, with the exact figure to be confirmed in the report from the external agency.
What’s in store?
The RBI expressed concerns about the CEO’s leadership capabilities, resulting in only a one-year extension. Such issues raise questions about the strength of internal processes and compliance. The discrepancies in the derivative book may also have contributed to the decision for a sub-optimal CEO tenure extension. The board is expected to accelerate the process of evaluating both internal and external candidates to appoint a suitable successor.
