State Bank of India [Get Quote], ICICI Bank [Get Quote], Bank of Baroda [Get Quote] and Bank of India are set to book mark-to-market losses on the exposures of their foreign offices to credit derivatives, with the spreads on these widening since international lenders turned risk-averse following the crisis in the US subprime (or high-risk home loan) market.

Credit derivatives are instruments for which the underlying asset is a loan or a bond. Marking to market means valuing a portfolio based on the prevailing market price.

The significance of this move is that the net profits of the four Indian banks would be dented for the third quarter ended December 31, 2007, to the extent of the provisions that they decide to make.

ICICI Bank, the country's second largest bank, has the highest exposure of $1.5 billion (approximately Rs 6,000 crore or Rs 60 billion). SBI, the country's largest bank, has an estimated exposure of $1 billion (Rs 4,000 crore or Rs 40 billion), BoI $300 million (Rs 1,200 crore or Rs 12 billion) and BoB $150 million (Rs 600 crore or Rs 6 billion).

The mark-to-market losses on these credit derivatives portfolios could range from 5 to 10 per cent. Though these over-the-counter exposures are not required to be marked to market by regulations, banks have been making provisions for them globally.

All four banks have already made provisioning on account of marking-to-market credit derivatives for the quarter ended September 2007.

A senior ICICI Bank official said: "We made a provisioning of Rs 100 crore (Rs 1 billion) in the quarter ended September 30, 2007. However, this impact was offset by other treasury income of Rs 300 crore (Rs 3 billion) to Rs 400 crore (Rs 4 billion)."

Close to 70 per cent of ICICI Bank's exposure to credit derivatives is to Indian corporations, while the remaining is to foreign companies.

For the second quarter of 2007-08 for mark-to-market losses on these exposures, BoB provided around $16 million (or close to Rs 60 crore or Rs 600 million) and BoI Rs 5 crore (Rs 50 million) to Rs 6 crore (Rs 60 million).

SBI did not respond to e-mail queries sent to the bank's chairman on the bank's exact exposure and provisioning requirements.

A BoB official said: "For the December quarter, the additional provisioning would be nominal; maybe a couple of millions more."

The Reserve Bank of India, in its latest progress report on banking in India, noted that some Indian banks with overseas operations do have some exposure to credit derivatives and there could be some losses due to mark-to-market impact.

However, it said such exposure was "very limited" and that banks did not have any direct exposure to the US subprime market, it said.

The main variants of credit derivatives include collateralised debt obligations and credit default swaps. 

CDOs are securities backed by pools of other securities and bought by investors wanting exposure to the income from a set of loans or bonds but not direct exposure to them.

CDS is an agreement whereby a lender transfers a credit risk to a counter-party (say, another bank), which agrees to insure the risk and receives periodic payments like an insurance premium.

If the lender's client (borrower) defaults, then the counter-party to the CDS agreement pays the lender the outstanding principal and any remaining interest and buys the defaulted asset.