Higher percentage of investment in government securities (g-sec) by Indian banks, which stood at more than 40% of aggregate deposits compared with developed countries like US (4.6%), UK (0.3%) and Euro zone(6.9%) has helped the banks to earn higher trading profits in the recent falling interest rates scenario. It has also increased the interest rate risk for banks. Using some innovative interest rate risk hedging instruments like interest rate swaps, interest rate futures and sale of longer maturity bonds, banks can reduce their exposure to interest rate risk.

In the recent period, steady deregulation of interest rates by RBI has increased the interest rate volatility. Interest rates have also fallen during the same period. To take the advantages of the falling interest rate regime, almost all the commercial banks in India increased their investments in government securities (g-sec).

Low credit demand by manufacturing sector and increasing awareness of credit risk among banks are also some of the major reasons for increased investment of commercial banks in g-sec. Even though they are earning higher trading margins due to falling interest rates, they could face higher losses if the interest rates start moving northward. There are definite indicators to this effect.

Innovative interest rate risk hedging instruments in the Indian derivative market can help the banks to manage the interest rate risk efficiently and effectively. Here, we discuss some of these instruments available in the market for Indian commercial banks.

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