RBI extends Foreign Exchange Risk Reserve to banks' own hedges, sets scope
The Reserve Bank of India has directed authorised dealer banks to hold a Foreign Exchange Risk Reserve (FERR) of 20% of the rupee value of qualifying forex derivative contracts, as interest-free cash with it. Directions of 10 and 12 October 2026 cover hedges buying foreign currency against the rupee; FAQs of 15 October set out the scope.
Syllabus: GS3 · Indian Economy & Growth; Prelims · Economy & Social Development
Why this matters for UPSC
GS3 Indian economy: the RBI's tools to manage the rupee. Prelims can ask how the Foreign Exchange Risk Reserve differs from CRR and HQLA, and what current and capital account transactions are under FEMA, 1999; Mains, about the cost of hedging.
Why it matters
Think of a company that imports machinery or electronics and pays its suppliers in dollars. To guard against a weaker rupee it books a derivative contract with its bank that fixes the price of the dollars it will buy. On large hedges of this kind the bank must now park a fifth of the contract's rupee value with the RBI, in cash that earns nothing, for as long as the contract runs. That ties up money the bank could otherwise lend or invest, and the RBI has not said how much of the cost will reach customers. Exporters who sell dollars are not touched. The larger question is how far a central bank should go in steadying a currency by making it dearer to buy dollars ahead of time.
Prelims pointers
- FEMA, 1999 (Act 42 of 1999) came into force on 1 June 2000; its long title aims at external trade and payments and an orderly forex market.
- FEMA Section 2(j): current account transactions include payments for foreign trade and services, interest on loans, net income from investments and family living expenses abroad.
- FEMA Section 2(e): a capital account transaction alters residents' assets or liabilities outside India, or non-residents' assets or liabilities in India.
- FEMA Section 5: any person may buy or sell foreign exchange for a current account transaction; the Central Government may restrict this in consultation with the RBI.
- FEMA Section 10: the RBI authorises persons to deal in foreign exchange as authorised dealers, money changers, off-shore banking units or otherwise; Section 11 lets it direct and penalise them.
- RBI Act Section 45W: the RBI may direct agencies dealing in securities, money market instruments, foreign exchange and derivatives, but not on settling trades on recognised stock exchanges.
- HQLA under the Basel III LCR must be convertible into cash easily and immediately in private markets; the Basel Committee first published the LCR in December 2010.
Practise a UPSC-style question
With reference to the Foreign Exchange Risk Reserve (FERR) prescribed by the Reserve Bank of India in October 2026, consider the following statements:
1. FERR balances can be counted as high-quality liquid assets under the Liquidity Coverage Ratio framework.
2. The reserve is kept as cash with the Reserve Bank of India and earns no interest.
3. The reserve applies to derivative contracts in which the user sells foreign currency against the rupee.
Which of the statements given above is/are correct?
- (a) 1 only
- (b) 2 only
- (c) 3 only
- (d) 1, 2 and 3
Show the answer
Answer: (b) 2 only
Answer: (b) 2 only. The FERR is unpaid cash held with the RBI that is neither HQLA nor levied on users selling foreign currency.
Statement 1: incorrect. The RBI's FAQs of 15 October 2026 say FERR balances are not eligible to be reckoned as HQLA under the Liquidity Coverage Ratio.
Statement 2: correct. The directions of 10 and 12 October require the reserve as cash with the RBI, and the FAQs say it earns no interest.
Statement 3: incorrect. The reserve applies only where the user buys foreign currency against the rupee; selling contracts are outside it.
Eliminate: Statement 3 is incorrect, since the FERR targets purchases of foreign currency. Out: (c), (d).
Eliminate: Statement 1 is incorrect, since FERR balances are not HQLA. Out: (a).
Trap: Reversed direction. Statement 3 keeps the right instrument but turns buying foreign currency into selling it, which is exactly the side the RBI left out.
Remember: FERR = 20% cash with the RBI, no interest, not HQLA, only on buying foreign currency against the rupee.
More from the 16 October 2026 edition
- Black Sea and the Turkish Straits: drone strikes hit merchant shipping World & IR
- India approves rollover of ₹30 billion currency swap for the Maldives World & IR
- Census Rules, 1990 amended to spell out who can be enumerators Polity
- Sports Ministry issues norms for revised National Sports Federations assistance scheme National
- Section 163 BNSS order and park closure curb Connaught Place assembly Polity
- India presses terrorism, connectivity norms at CICA's Baku summit World & IR
- ISRO: Aditya-L1 and Proba-3 coronagraphs jointly study coronal mass ejections Sci-Tech
- Centre cancels paraquat herbicide's registration; Madhya Pradesh orders stocks destroyed Environment
- UN DESA's World Social Report 2026 scores 168 countries on inclusive transformation World & IR
- AT-1 bonds: Supreme Court upholds quashing of Yes Bank write-down Economy
- CERT-In issues critical advisory on AI agents reaching Indian systems Sci-Tech
- UN report urges limits on neurotechnology and neural data in justice Sci-Tech