NOOP limit

A bank that deals in foreign exchange ends each day with a position. It has bought more of some currency than it has sold, or the other way round. That leftover is an open position, and overnight it is unhedged risk: the rate can move before the market opens again.

The NOOP limit is the cap on that leftover. NOOP stands for Net Overnight Open Position.

The workbook describes the limits as dual in nature. One is the Net Overnight Open Position Limit (NOOPL), used for calculating the capital charge on forex risk. The other is a limit on positions involving the rupee as one of the currencies (NOP-INR), used for exchange rate management.

Who sets the number? The bank's own board. It then has to tell the Reserve Bank of India immediately.

But the board is not free to pick anything. The limit must not exceed 25% of the bank's total capital — Tier I and Tier II together — or any other condition the RBI specifies from time to time.

And the limit is not a market-hours rule. It must be maintained all the time.

Where it comes from (Chapter 1, section 1.3.6, Market Timing). The passage is about FEDAI market hours, and the NOOP condition is attached to trading outside them. FEDAI stipulates normal market hours for FCY/INR transactions in the interbank forex market and for client transactions of 9.00 a.m. to 5.00 p.m. IST on all working days. Authorised dealers may undertake customer and interbank transactions beyond normal market hours — and for any such transaction, the bank must ensure that the NOOP limit is maintained all the time, including for transactions executed from end of day to 9.00 am IST, the next working day's market opening.

The two limits. The Foreign Exchange Exposure Limits of Authorised Dealers are dual in nature:

How the limit is fixed and what it covers.

• NOOP limit may be fixed by the boards of the respective banks and communicated to the Reserve Bank of India immediately.
• Such limits should not exceed 25 percent of the total capital (Tier I and Tier II capital) of the bank, or any other condition specified by RBI from time to time.
• For banks incorporated in India, the exposure limits fixed by the Board should be the aggregate for all branches including their overseas branches and Off-shore Banking Units.
• For foreign banks, the limits cover only their branches in India.

That last pair is the examinable asymmetry. An Indian bank's limit is a global number; a foreign bank's limit is an India-only number.

Why a currency derivatives candidate meets it. The banks that carry NOOP limits are the AD Category-I banks that are also participants in the exchange traded currency derivatives market, and their trading-desk capacity is bounded by this limit rather than by anything the exchange imposes. It is a prudential ceiling on the bank, not a position limit on a client.

Sizing the cap. Illustrative capital figures; the workbook gives the 25% rule but no bank's numbers.

A bank incorporated in India has:

Its board fixes the NOOP limit at Rs 1,800 crore and communicates that to the RBI immediately. Rs 1,800 crore is the operative limit; Rs 2,500 crore is merely the highest the board could have chosen.

What the limit has to cover.

Had this been a foreign bank, the limit would have covered only its branches in India.

Where the 5 pm rule and the limit collide. At 6.10 pm a corporate client asks the bank to sell it USD 30 million.

At a USDINR rate of 83, USD 30 million is about Rs 249 crore of exposure — 14% of the Rs 1,800 crore limit on that one ticket. Value cash transactions, note, may be undertaken only up to 5.00 pm IST in any case, except for individuals, joint accounts and proprietary firms.

Chapter 1, section 1.3.6 (Market Timing), is the only place NOOP is taught, and it teaches it as a condition on after-hours dealing. The examinable facts are the expansion of the abbreviation, the dual nature of the limits (NOOPL for the capital charge, NOP-INR for exchange rate management), who fixes the limit (the bank's board, communicated to the RBI immediately), the 25% of total Tier I plus Tier II capital ceiling, and the Indian-bank-versus-foreign-bank coverage difference. It pairs naturally with the FEDAI market hours in the same section.

• The board fixes the limit; the RBI is informed. The RBI does not set each bank's number — it sets the ceiling and the conditions.
• 25% of total capital means Tier I plus Tier II, not Tier I alone.
• There are two limits, not one. NOOPL is for the capital charge on forex risk; NOP-INR is for exchange rate management.
• An Indian bank's limit is the aggregate for all branches, including overseas branches and Off-shore Banking Units. A foreign bank's limit covers only its Indian branches.
• The limit applies all the time, including from end of day to 9.00 am IST, and is not relaxed for after-hours trading.
• Trading after 5.00 pm is allowed; value cash after 5.00 pm generally is not (except individuals, joint accounts and proprietary firms). Those are two different rules in the same section.
• NOOP is a prudential limit on an authorised dealer bank, not an exchange position limit on a client or a trading member.