As reported by Partha Sinha in on 13 Sep 2011:

Banks violated FEMA in derivatives trading, says RBI

MUMBAI: In the last six months, the Reserve Bank of India (RBI) has penalized 20 banks for violations of its directives on derivatives contracts, and the banks got away with fines between Rs 5 lakh and Rs 15 lakh. The RBI releases mention that the penalties were imposed for contravention of various instructions issued by the regulator in respect of derivatives, like failure to carry out due diligence in regard to suitability of products, selling derivative products to users not having risk management policies among others. Now a reply from RBI to an RTI application by a Delhi-based lawyer has shown that some of the banks had also violated Foreign Exchange Management Act (FEMA), which is a criminal offence.

In its RTI reply to Karan Jain, a lawyer at Delhi high court, RBI said that "compliance function in certain banks had failed to ensure strict observance of the provisions of FEMA." However, the banking regulator declined to share with the RTI applicant its findings of inspections of banks' on the ground that such findings were "confidential in nature" and "disclosure of which would prejudicially affect the economic interests of the state and harm the bank's competitive position".

With RBI now admitting that the FEMA was violated, Jain, the RTI applicant, expects the authorities to move against banks for such criminal violations. "Whose responsibility is it to enforce FEMA?," Jain asked. "Admittedly, the losses from these contracts are losses to the economy. So is it not for ED ( Enforcement Directorate) to take suo motu cognizance of the FEMA violations?" he asked.

The cases relate to 2007 and 2008 when several banks were selling foreign exchange derivative contracts to corporates, several of which were sold projecting profits for the buyers on the assumptions that certain currencies will move favourably. However, as some of the major currencies like Swiss Franc showed unusual movement, a large number of corporates lost money. Subsequently, while several court cases were fought between the companies and the banks, a public interest litigation (PIL) in the Orissa high court ordered that CBI should investigate the whole matter. The HC order was then challenged by the national body of the foreign exchange dealers in the Supreme Court, saying that the appropriate investigating authority in this case is the RBI and not the CBI.

The apex court is yet to rule on whether CBI or RBI should investigate the alleged violations of forex derivatives rules by banks, and the next hearing is slotted for September 27.

On Friday, RBI fined two banks__Credit Agricole and Karnataka Bank__for violations of its directives for banks while dealing in derivatives contracts. The two banks joins another 18, which include biggies like SBI, HDFC Bank, ICICI Bank, Citibank, Standard Chartered Bank and HSBC, that were fined for similar violations in April this year. The fines ranged between Rs 5 lakh and Rs 15 lakh. While the RBI release on the penalties mention that these banks had violated derivatives-related rules and directives, but the same did not mention FEMA violations by these banks. This could be because while RBI is empowered to take action against banks under banking regulations and some other rules. The banking regulator, however, can not take any action against banks under FEMA, said Dhananjayan, advisor to Forex Derivatives Consumers' Forum, a group of exporters in Tamil Nadu who suffered huge losses after buying forex derivatives contracts from banks and is one of the parties in the Supreme Court case.