Low cost helps banks mop up $34 billion in foreign currency deposits; rupee gets a boost

The Reserve Bank of India (RBI)’s out-of-the-box move to woo dollar deposits by protecting banks from currency risks has been a big hit.

Banks have managed to mobilise $34 billion in foreign currency deposits since the special swap scheme was flagged off in September.

This is much higher than the sums raised by the Resurgent India Bonds (RIBs) of 1998 ($4.2 billion) and the India Millennium Bonds ($5.5 billion). The inflows have given the rupee a much-needed breather from its steady slide over the past year.

Win-win for banks

But since banks have always had the option of raising FCNR (B) deposits, what has made them so attractive now? The low cost of this option was the major reason. Usually, an interest rate of 400 basis points over Libor is paid on dollar deposits to NRIs. To service the deposit, the bank would have to buy a currency hedge, paying about 7 per cent a year.

Effectively the bank ended up footing an interest cost upwards of 12 per cent on each deposit.

But with the RBI subsidising the hedging cost at a fixed 3.5 per cent, the effective cost of funds for FCNR deposits has plummeted to 8.75- 9 per cent. This made it an attractive option, similar to raising domestic deposits.

S. Srinivasaraghavan, Head of Treasury at Dhanlaxmi Bank, said, “We saw very high collections because of aggressive campaigning by banks and the added incentive of raising funds at 1 per cent less than market rates. Also, it provided a cheaper cost of funding to banks compared to funding through domestic deposits which were around 10 per cent at that time.”

Concerns too

Abheek Barua, Chief Economist, HDFC Bank, points out that deposits being in the nature of debt, “we must be prepared to handle large outflows at a future date”.

“While NRI deposits have been sticky in the past, there is no guarantee that they will rollover when these deposits mature.”

But market experts are pinning their hope on new foreign portfolio flows into the bond market with the inclusion of Indian gilts in the global indices. According to Bank of America Merrill Lynch, inclusion of Indian gilts in the emerging market bond index can help in raising $20-25 billion from the global debt funds.

Besides, the RBI has also incurred a cost to raise these deposits as the central bank bears any currency risk above the 3.5 per cent paid by the banks. “If the total FCNR (B) deposit mobilised is $10 billion, the RBI swap subsidy may result in a subvention at $1.9 billion based on the short- term rate of 9 per cent.” says Soumya Kanti Ghosh, Chief Economic Adviser, SBI.

Wonders of leverage

Some banks have FCNR deposits to offer attractive leveraged products to NRIs, which have multiplied the flows through this route.

Here is how the leverage works. An NRI who deposits dollars in an overseas branch gets an overdraft on the deposit which, in turn, is brought as an FCNR (B) deposit into the Indian branch.

If an NRI deposits $1,000 in an overseas branch and gets an overdraft of say $9,000 as lien on the deposit, $10,000 gets deposited into the Indian branch as FCNR (B).

Now here’s the math. The bank pays the depositor interest on the $10,000 deposit at Libor plus 400 basis points for three years. On the other hand, the bank earns interest on the amount it lends in India ($10,000) as well as on the overdraft ($9,000) given to the NRI.

Hence, both the bank and the depositor benefit from such returns. “In effect, the annualised profit rate of the overdraft amount invested in India by the bank may be close to 10 per cent. Additionally, the NRI investor earns an annualised return up to 17-18 per cent on his initial investment. This is attractive both for the bank and the depositor,” says Soumya Kanti Ghosh, Chief Economic Adviser, SBI.

Also, he says, “Banks need not maintain cash reserve ratio or statutory liquidity ratio on such deposits.”

(This article was published on December 6, 2013)
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