By Kim Jae-kyoung
Staff Reporter

Local banks stand to face huge losses after the Seoul Central District Court ruled in favor of domestic companies, Tuesday, invalidating currency option contracts between SC First Bank and two exporters.

The court ruled that DS LCD and MonAmi were freed from their obligations associated with their knock-in knock-out (KIKO) deals with SC First as of Nov. 3 when they filed the request with the court for cancellation of the currency option contract.

This means the two companies will have to shoulder losses incurred before the lawsuit but will be released from any that have occurred, or will occur, during the remaining period of the contracts.

``The bank failed to fulfill its duty to protect its client and the contract has lost the basis of its rationality as volatility in the exchange rate has rapidly increased,'' the court said.

KIKO options allow businesses to sell dollars at a fixed won/dollar rate if the exchange rate stays within the range fixed in the contract. If it soars above the upper limit, however, exporters can sustain huge losses, as they have to pay more for dollars on the currency market to sell them at the fixed rate to the banks. With the won plunging against the dollar in recent months, many local businesses suffered massive losses and are now on the brink of bankruptcy.

With the court ruling, banks are likely to face a myriad of similar lawsuits from local companies suffering from big losses from currency hedging derivatives.

According to the Korea Federation of Small Business, 471 small firms were holding KIKO contracts worth $5.9 billion in August ― of them, 170 reported KIKO-related losses estimated at 1.8 trillion won at an exchange rate of 1,300 won to the dollar. Of that total, 1.1 to 1.2 trillion won has yet to be paid.

If all these firms file requests with the court to cancel their KIKO contracts, and they benefit from similar rulings, banks will have to shoulder that amount in losses.

kjk@koreatimes.co.kr