Explained: How RBI’s safety net to protect falling rupee could mean Rs 4,000 crore shock for banks

The Reserve Bank of India’s (RBI) emergency intervention to arrest the rupee‘s freefall amid the Iran war has set up a potential Rs 4,000 crore hit to the banking sector, as lenders race to unwind billions of dollars in arbitrage positions before an April 10 deadline.

The rupee rebounded nearly 1% to 93.85 per dollar on Monday after the RBI capped banks’ net open positions at $100 million at the end of each business day, a dramatic tightening that forces lenders to dismantle large one-sided bets against the currency. But the banking sector paid an immediate price.

Nifty Bank tumbled 2.5%, with Axis, Kotak, and IndusInd Bank leading losses with 3% declines, while ICICI, HDFC Bank, and SBI fell around 2% each.

The directive comes as the rupee has depreciated roughly 10% this fiscal year and 3.5% since the Gulf conflict began, falling from 85.57 per dollar on April 1, 2025, to 90.98 by February 27, a day before the war started, ultimately hitting a record low of 94.84 last Friday.

The Mechanics of Pain

The potential losses stem from how banks had structured their foreign exchange operations. Lenders built substantial arbitrage positions by buying dollars in the onshore market at lower premiums and selling them in the offshore non-deliverable forwards market at higher premiums, exploiting the spread between the two segments. The size of such positions is estimated at $25 billion to over $50 billion, according to Reuters.
“We understand that the forex derivative market is dominated by larger banks (Indian banks like SBI, ICICI, HDFC, Axis, and leading foreign banks operating in India) with gross onshore positions of $30-40bn that offset each other,” wrote Prakhar Sharma and Vinayak Agarwal of Jefferies. “The normal trade is for banks to buy USD in the onshore market (at a lower premium) and sell/ square off in the offshore market (at a higher premium) to generate a spread and build depth in the market.”
The analysts warned that unwinding these positions could trigger mark-to-market losses in the fourth quarter. “Every Rs1/USD dual movement in INR on $30-40 bn of book can lead to a one-time loss of Rs 30-40 bn (Rs 3,000-4,000 crore) for the banking sector,” they noted. If the gap between rupee-dollar rates in the NDF market and the onshore market widens to Re 1 during unwinding, traders said banks could face losses of up to Rs 4,000 crore, reflected in current fiscal year books, as banks had calculated open positions after netting off hedged NDF trades.

Why the RBI Acted

The central bank’s intervention comes amid intense pressure on the rupee from multiple fronts. The currency has tumbled through key psychological levels in quick succession, pressured by surging crude oil prices and concerns that the Gulf war may not end soon.

The spread between offshore and onshore markets had widened significantly amid heightened volatility and risk aversion tied to oil-driven pressures linked to the Iran war.

“The measure compels lenders to scale back large positions and curbs their ability to build aggressive one-sided bets against the rupee,” said Jigar Trivedi, Senior Research Analyst at IndusInd Securities. “The intervention comes as the rupee has declined more than 4% over the past month, falling to around 94.82 per US dollar. Pressure has been compounded by sustained capital outflows, including over $11 billion withdrawn from Indian equities and record bond outflows of $1.6 billion in March, further weakening demand for the currency.”

Banks seek relief

The banking sector has sought leniency from the RBI on implementation. “Our conversations with banks indicate that the RBI is considering some relief, which may include grandfathering existing contracts and applying limits only to new contracts,” Jefferies analysts wrote. “It may also consider extending the deadline beyond April 10 to allow for smoother forex market movement and reduce MTM impact on banks.”

Most large and mid-sized banks with net open positions exceeding $100 million are expected to sell dollars to comply with the directive, potentially triggering a wave of onshore dollar selling as they rush to unwind arbitrage positions.

Not everyone views the potential losses as catastrophic. Fund manager Samir Arora offered a contrarian take: “Just relax about this supposed Rs 4,000 crore loss on FX unwinding. In just the past month, the INR has depreciated by over 4%. These positions would not have been set up for the first time at Friday’s close. Banks would be sitting on significant gains by now (which equity markets may not have fully priced in), and they will simply give up some of those profits. Big deal.”

Arora also suggested the impact may be concentrated elsewhere: “Some of the larger positions may have been taken by more aggressive foreign banks (like Citi, etc.). That’s not a major concern for our markets.”

The road ahead

While the RBI’s move may provide temporary support to the rupee, traders remain cautious about the currency’s trajectory. If the West Asia conflict persists and crude oil prices remain elevated, the focus could quickly shift back to the 96–97 per US dollar range in April as the next pressure zone, traders warned.

The unwinding may also create winners. Appreciation of the rupee in the NDF market could lead to gains for hedge funds and foreign banks in forex derivatives, Jefferies analysts noted.

For now, the central bank has bought breathing room for the rupee, but at a cost the banking sector is likely to bear in its Q4 earnings.