The Echo-nomist

Banks usually just take deposits and lend money. The difference between the interest rates on the loans they give and the deposits they keep is the profit that banks earn. On the face of it, yeah. But it’s more complicated than that.

When they take deposits and lend money, is it in Dollars or Rupees or Pounds or Euros? If it’s in multiple currencies and the value of rupee drops then paying the depositors back in dollars could be expensive.

The interest rate spreads don’t give banks enough profit sometimes so they decide to dabble into hedging and betting on currencies. High risk, high reward, right?

Every bank does this. IndusInd is nothing special. Why, then, did the 5th largest banks’ stock drop? And by drop I mean dived 27%, wiping out ₹19,000 crores in market value. Nothing too crazy.

IndusInd bank has been big on forex deposits in recent years. They were even offering attractive interest rates to lure in foreign currency inflows. By Q3FY25, around 14.3% of the bank’s total deposits were NRI deposits.

NRI deposits bring in stable, low-cost foreign currency funding, which helps banks expand their lending capacity. They also diversify the bank’s deposit base, reducing reliance on domestic sources. But since these deposits are often long-term, they require some protection against currency volatility. That’s where hedging comes in. If rupee weakens, the bank would have to pay back more in rupees when the deposit matures. Forex derivates like currency swaps and forwards act as an insurance against this volatility. The bank enters into a contract today that locks in the exchange rate for a future date. If exchange rates move against the bank, the hedge works and the banks book a gain on the derivative. If the exchange moved in favor of the bank, it results in a small loss for the bank but prevents a much bigger uncertainty.

The problem with IndusInd was how they accounted for these hedges.

They followed a dual approach: external trades with the market and internal trades within its own books.

External Trades refer to trades with customers and like other banks or financial institutions. For these, the price of the trade is recorded everyday using mark-to-market accounting (MTM). MTM is just an accounting method that values assets and liabilities at their current market price rather than their historical cost. The profit or loss is reflected immediately, it’s completely transparent and reflects what’s happening in the real world.

Internal Trades are derivative-like contracts between different departments within the bank (example- business and treasury units) to manage their forex risks. They’re not backed by real market exposure so their price isn’t tracked everyday. The fixed “cost” or “value” is noted down and then IndusInd waits. In theory, value of these trades will match the external ones over time and that’s what they assume.

Suppose a bank accepts foreign currency deposits and hedges the exposure using both external and internal trades. External hedges are marked to market daily, so any gain or loss is immediately recognized in the profit and loss (P&L) statement. Internal hedges, however, usually remain static in the books. Since one of the hedges reflect real-time changes and the other doesn’t, a mismatch can occur. The problem comes in when the original deposit is withdrawn early (say in 2 years instead of 5). Now the bank will close both the trades. While the external hedge reflects the true market impact, the internal hedge might still be recorded at its original value, thereby masking actual losses that should have been recognized earlier.

What IndusInd did is, that they didn’t admit the actual loss in their balance sheet even after closing the trade early. They noted it down as “receivables” under “intangible assets” on their balance sheets. You know how you push your problems to deal with later, exactly like that.

Bottom line is, IndusInd was recording profits from their hedges as income and hiding the losses in their balance sheets. Now their balance sheets look healthier because the loss isn’t obvious. They were going to account for these losses gradually. However, given IndusInd’s massive unhedged forex positions, this became a problem when RBI’s new rule was announced.

In September 2023, the RBI announced that banks have to check and report all their trades properly, including hedges with effect from April 1, 2024.

But if it was effective from April 1, 2024, why did their stock start falling in March 2025?

The bank stopped internal hedging in April’24 but they weren’t fully sure about their accounting procedures for the internal trades and the amount of losses that they had buried. So in Oct’24, they hired an external agency to verify the numbers. When their review was completed in 2025, they found that IndusInd had overstated its net worth by about ₹1,500 – 2,000 crore (approx. 2.4% of the bank’s net worth as of December 2024). This has been accumulated for 5-7 years up to April’24.

The Managing Director and CEO, Sumant Kathpalia, said “our profitability and capital adequacy remain healthy to absorb this one-time impact.” You can read the press release here.

5 days later, the RBI also released a statement stating that the bank’s liquidity coverage ratio was at 113% on March 9, 2025 as against the requirement of 100%. They also mentioned, “there is no need for depositors to react to the speculative reports at this juncture.” (Read RBI’s press release here)

Things were starting to go back to normal for the bank when the forensic probe led by Grand Thornton was completed.

They found that the deputy CEO, Arun Khurana, was aware of serious accounting irregularities related to internal derivative trades. There are emails exchanged between him and the finance team, where one instance shows that he ignored warnings flagged by the finance department.

2 days later the report reached the bank’s board and Khurana resigned.

In March this year, the CEO, Sumant Kathpalia, had been cleared for a three-year extension by the board but the RBI only approved a one-year extension. Following Khurana’s resignation, Sumant Kathpalia also tendered his resignation, taking “moral responsibility” for the whole thing.

The audit found a ₹1,959.98 crore loss that was misreported.

The RBI stepped by authorizing the board to establish an executive committee to run day-to-day operations for the bank in absence of a CEO and Deputy CEO.

This just acts a reminder that banks need to sort out their internal practices. The main thing they lost was public trust. That’s not easy to earn back, and kind of a big deal for a business based on trust.