We have all read about the infamous derivative losses on Indian companies Balance Sheets. This article aims to address some points from both sides. A neutral introspection into what really happened. It is quoted on the internet that "Forex derivative contracts to the tune of $3 trillion were traded in India as on December 2007 whereas the total foreign exposure of India was not more than $500 billion annually. Companies across sectors entered into derivative agreements with nationalised and private banks to safeguard their foreign exchange risks." So, what can be made from the above statement. $3 trillion of derivative contracts versus $500 billion of foreign exchance exposure. This clearly means that there was a lot of activity in the OTC derivative segment with Bank selling these to various corporates and thereafter cancelling them due to volatile exchange rates. Continuing with the original story, given below are some case points. A. Why Corporates were at fault. It is said in many newspapers that Banks were at fault when they were involved in mis-selling derivative contracts to clients. To counter this, it should further be added that these contracts were often exotic and structured products. Even if the Bank were to take adequate care by way of processes and controls to ensure that clients understood the contracts, it is very unlikely that corporates could understand the pricing and the true underlying in the contract. Even many bank employees outside of treasury could not properly understand these contracts. So, it is unforunate that banks are blamed for misselling. Infact, banks in general sold these products because corporates were willing to purchase these. It was more a case of mis purchase than a case of mis-sellling. B. Why Banks were at fault Now coming to why banks were at fault and corporates were the innocent lot. In many situations, it was noted that very few people in the corporates interacted with the Banks on these contracts. Often the losses of past derivative contracts were resturctured in anticipation of future gains. Banks should have taken appropriate Baord resoultions, agreements, documentation that would ensure them that the Baord/Top management was aware of these contracts and the potential risks. Banks treated the client derivative segment as a hot business segment forgetting that derivative by nature is a highly leveraged instrument. To cover a corporate's exposure, it is sufficient for corporates to purchase plain vanilla contracts rather than exotic. ie what is the sense in selling a contract such as 20% of the gains of the underlying INR/USD when the YEN movement over next 25 days is upto 30% cap and together with floor of........ Just sell him a simple USD/INR contract to hedge the US$ position.