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MUMBAI, March 20

CORPORATES and banks that are engaged in interest rate derivatives trading must have a clear understanding about the risks associated with the product, according to Ms Usha Thorat, Chief General Manager, Reserve Bank of India.

Speaking at a Business Asia Consulting seminar on `Interest rate Derivatives, The Roadmap Ahead,' Ms Thorat said, ``Clear and enunciated risk management policies must be in place for the use of derivative products. The role of internal control and audit is very important as they must be able to recognise and anticipate risk''.

It is the concern of supervisors in any risk management practice that there isn't any kind of oversight by a company board and banks, she said.

The scope for developing the Indian derivative market is huge as every entity has an underlying exposure to interest rates.

``So it is but natural that interest rate derivative market go into these dimensions'', she said.

Ms Thorat emphasised, that it is important to have a global perspective on interest rate derivative market, as the world over, in OTC derivative markets, the notional traded value is estimated at around $100 trillion of which interest rate derivatives constitute 75 per cent.

In developing markets, there are concerns, which have to be addressed with regard to inadequate documentation and inadequate conformation of contracts.

Market infrastructure might also pose operational risks in case of breakdown in technology or telecommunications systems. Therefore, it is important to formulate and follow financial best practices, she said.

While there may be some ambiguity on the legalities of OTC and interest rate derivatives, many banks and companies try and circumvent these problems by getting into different jurisdictions for their contracts. Central Banks are interested in derivative markets on account of systemic stability. Supervisory issues involve the soundness of financial entities that intermediate between financial users, said Ms Thorat.

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