RBI's Foreign Exchange Risk Reserve: How the New 20% Rule on Rupee Derivatives Works
On October 10, 2026, the Reserve Bank of India (RBI) issued a circular (A.P. (DIR Series) Circular No. 26) to all Authorised Dealers (banks allowed to deal in foreign currency). It asks them to keep a new Foreign Exchange Risk Reserve (FERR).
The reserve applies to forex derivative contracts involving the rupee (contracts that fix a future exchange rate) that a customer takes to protect a current account deal, such as paying for imports, where the customer is buying foreign currency against rupees.
Only contracts with a notional value (the full face amount of the deal) above USD 2 million are covered. For each such contract, the bank must keep 20% of the rupee value of the notional amount as cash with the RBI, every day, until the contract ends.
An anti-circumvention rule says a customer cannot break one large deal into smaller pieces, with one or more banks, to stay below the USD 2 million limit. Doing so counts as a violation.
Banks must report FERR details daily through the RBI's Centralised Information Management System (CIMS), its central data-reporting platform. The rule covers contracts taken after the circular was issued.
The RBI used its powers under Sections 10(4) and 11(1) of the Foreign Exchange Management Act (FEMA), 1999 and Section 45W of the RBI Act, 1934. The circular amends the Master Direction on Risk Management and Inter-Bank Dealings (2016). It came as part of a wider set of steps to support the rupee, which closed at 96.73 per US dollar on October 9, close to its record low of 96.96.
Foreign Exchange Management Act (FEMA), 1999
FEMA is the main law that controls how money moves between India and the rest of the world. It replaced the older and much stricter Foreign Exchange Regulation Act (FERA), 1973, and came into force on 1 June 2000. Under FEMA, the RBI makes the detailed rules for foreign exchange, and only "authorised persons" (mainly banks called Authorised Dealers) can deal in foreign currency with the public. FEMA treats breaking its rules as a civil wrong punished with money penalties, not as a crime.
The FERR circular is a direct use of the RBI's power under Sections 10(4) and 11(1). Because banks are "authorised persons", they must obey it, and the anti-circumvention clause makes deal-splitting a breach of RBI directions under FEMA.
Currency Hedging and the Forward Premium
Currency hedging means protecting yourself against a sudden change in the exchange rate. An importer who must pay dollars three months from now can sign a contract today that fixes the rupee price of those dollars. Such contracts are called derivatives because their value comes from (is "derived" from) the exchange rate. The most common ones are forwards, futures, options and swaps.
The FERR targets exactly one kind of hedge: rupee derivatives above USD 2 million where the user is buying foreign currency for current account deals. By making the bank lock up 20% of the notional value as cash with the RBI, the rule makes these contracts costlier to offer. This is expected to slow down dollar buying through derivatives at a time when the rupee is under pressure. Along with this, the RBI barred rebooking of forex derivatives and cut the limit for positions in exchange-traded rupee currency derivatives from USD 100 million to USD 5 million.
Exchange Rate Management in India: RBI's Managed Float
India follows a managed float. This means the market, through the demand for and supply of dollars, mostly decides the rupee's value. But the RBI steps in when the rupee moves too sharply. The RBI does not defend any fixed rate. It aims to stop wild swings (volatility) that can hurt importers, exporters and investors.
The FERR is an example of the RBI managing the rupee through rules, not just by selling dollars. Instead of spending reserves, it makes certain kinds of dollar demand (through large hedging contracts) more expensive, so pressure on the rupee eases.
- Circular: RBI/2026-27/292, A.P. (DIR Series) Circular No. 26, dated October 10, 2026; addressed to all Authorised Dealers
- FERR rate: 20% of the INR equivalent of the notional amount of each covered contract
- Threshold: contracts with notional value above USD 2 million equivalent
- Covered contracts: INR forex derivatives used to hedge current account transactions where the user buys foreign currency against rupees
- Reserve kept: in cash with the RBI, daily, until the contract ends
- Deal-splitting across one or more banks to avoid the rule = violation of the Directions
- Daily reporting through RBI's CIMS
- Legal basis: FEMA 1999, Sections 10(4) and 11(1); RBI Act 1934, Section 45W
- Amends the Master Direction on Risk Management and Inter-Bank Dealings (5 July 2016)
- Related steps: rebooking of forex derivatives barred; exchange-traded rupee currency derivative position limit cut from USD 100 million to USD 5 million
- Rupee: 96.73 per USD (October 9, 2026 close); record low 96.96 (May 2026)