RBI said to query bank valuations of some bond derivative trades

Reserve Bank of India said bond-forward trades should use Level 3 inputs for valuation.

During in-person regular audits in recent weeks, the Reserve Bank of India said bond-forward trades should use Level 3 inputs for valuation, the people said, asking not to be identified because the discussions were private.

Level 3 is used when a trade’s value cannot be easily checked against observable information in the market, and relies on a bank’s own assumptions. The classification can force banks to limit dividend payments and leave them with less regulatory capital, under RBI rules.

India's central bank has informed some lenders about the need to adjust bond forward accounting practices. This change could impact billions of dollars in assets across the banking sector. The Reserve Bank of India suggested using Level 3 inputs for valuing bond-forward trades during recent audits. Banks have been in discussions with industry associations and clearinghouses for potential solutions and better pricing information.

Banks widely sell bond forwards to insurers, which use them to lock in future bond prices and protect against swings in interest rates. The notional value of such trades totaled 1.1 trillion rupees ($11 billion) this year, according to clearinghouse data.

Banks have discussed the issue with the Fixed Income Money Market and Derivatives Association of India in recent calls and are seeking a resolution, they said.

Lenders have also held informal talks with the Clearing Corp. of India Ltd. about providing more pricing information to its trade repository, according to the people. The clearinghouse has separately begun trials of an electronic bond-forward trading platform that could improve price transparency.

The RBI, FIMMDA and the Clearing Corp. did not immediately respond to emails requesting their comments.