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RBI With Rajan Opens a Swap Window For FCNR Deposits With Banks

The new RBI Governor, Raghuram Rajan, attempts to open the floodgates of foreign capital into India. Banks that raise Foreign Currency Non-Resident (FCNR) deposits can now get rupees against them while hedging the exchange rate risk for a mere 3.5%.

FCNR Deposits are made in foreign currencies and are returnable in the same foreign currency. So the deposit rates have tended to be low and comparable with similar tenure foreign exchange deposits abroad. Of course, that rate, for dollars, is a likely to be a little lower:

US 3-year bond yield(From

Currently when an Indian bank promises a return on the FCNR deposit, it must convert the currency into rupees and deploy it locally. The cost of hedging the dollar out is about 6-7% per year, and the rupee return is about 10% per year, so the FCNR deposit is priced at very low levels.

But now, the RBI has a 3.5% rupee swap for all FCNR deposits with a 3 year tenure of the deposit. (See notification). That means, banks give the RBI dollars, the RBI will give them rupee equivalent now, and take the same rupees back + 3.5% p.a. when the swap is unwound and return them the same dollars. Effectively the cost of hedging the FCNR deposit is 3.5% per annum for a bank, which will increase their margin.

(3.5% hedge cost, 3% can be offered to customer = 6%, and they can get 9-10% on a govt bond for the 3 year period)

Also RBI will allow banks to swap foreign currency borrowings of upto 100% of their Tier 1 Capital (was 50%) at a swap rate that is 1% less than market rates. For example, three month rates which had spiked to 9%+ recently will be offered to banks at 8% (1% less than the equivalent market rate that day).

Of course, if a bank chooses not to hedge, and the dollar actually loses value, banks stand to lose (in comparison). At that point, the bank will make a lesser return than it should have, as the market implicitly assumes a 6-7% depreciation per year.

If played appropriately, with little or no risk, the availability of such swaps can be a  money spinner for banks.

This is hugely positive for the bank index (which is up over 7% today), and the rupee (USDINR at less than 66 today). It also has the biggest real impact in the much-hyped Rajan statement yesterday. I will note the rest in a separate post, but I thought this warranted a post by itself.

(Thanks to the good folks on twitter: @cornerd, @pranayshetty, @PineTreeInvest)

  • Gurpreet says:

    What if US Bonds rate go above 3%..already at 3.. it FCNR still lucrative for the extra 50 bps..?
    Money spinner for banks ..yes.. ONLY until short-term rates are above 9-10%.
    OR Is RR implying that short-term rates wld stay high ..???

  • Leo says:

    he has made things worse time will tell wait when INR depreciates to 71+ their head will spin

  • Ramamurthy says:

    There must be a catch somewhere.Otherwise why Mr Subba Rao did not do this?

  • mangoman says:

    This cannot be so easy.
    Somewhere somebody is borne the risk. Can you be more specific? especially how the RBI is not exposed to currency risk in this swap?
    Because this looks easy money making opportunity.

    • What risk? RBI is taking dollars. It is going to give back the same amount of dollars, at whatever Rs. is borrowed, with 3.5% p.a. interest. RBI has no risk, banks have no risk. RBI should be giving money at the 10.25% MSF rate but because we want dollars we will do this.
      Risk for banks is: Boss, I give dollar for Rs. 66 today, three years later it is 55, but i have to pay 66 only to get the dollar back. But then they have to pay out dollars only plus the FCNR rate.

  • AVV says:

    1. Banks are getting indirect subsidy
    2. The implicit assumption is NRI are willing to give FCNR B deposit even today but banks are not raising them because it was not lucrative for them. With subsidy it is assumed that bank will encourage NRI to do carry trade i.e. borrow in dirhams/USD at 1% and deposit at 3.5% for a risk free return of 2%+ for the borrower and somewhat risky return of 3%+ for banks
    3. If the above is correct, dollars will flood in India (assuming NRI will have faith and more importantly their carry trade lenders have faith that Indian bank will honor its commitment 3 years hence). Which means BoP will turn into surplus instantaneously. But still assume that rupee does not harden too much to make the trade not lucrative to banks.
    4 Assuming the above happens there will be no incentive for Indian Government to do any reforms as the pressure from foreign currency is gone which means inflation will remain at elevated level growth will remain stunted as no one will want to invest.
    5 interest rates will fall as liquidity will increase
    Looks like everybody will be happy, exchange rate will stabilize, govt will be free to spend, subsidies imported products with impunity, industry will get lower interest rates, Banks will make supernormal profit to pay for inevitable NPAs.
    RGR have achieved to impossible in just two hours at RBI.

    • Leo says:

      this is nothing but keep fed funds rate at 0 and lend out car loans and treasury bonds at 3 % something like that
      ther eis a catch they do this carry trade assuming rates wont rise…my logic says rates will rise dramatically in coming months so all these goons will get stuck with this carry trade and create a lehman moment.
      Raghuram ravan hona tha iska naam than rajan instead of raising rates he is actually create more panic.Imf ka banda hey aur kya karega

  • mangoman2012 says:

    Let me paraphrase..
    1. RBI will take fresh fcnr dollars deposits from banks and give them rupee equivalent for a fixed amount ( say 3.5%)
    2. If not, where will these dollars are deployed by the banks? are they just lying waste with banks? banks also would use somewhere right? Will that not affected?

  • d k dhingra says:

    All is well that end well.
    whether this is going to end well, only time will spell out but one thing is sure that it will depend upon towards modality of utilization of the foreign exchange i.e. the flood of the dollars into the country through this route.
    if the incoming dollars are used to subsidize the import of gold and for oil imports the doom day has been just postponed- particularly when the high end vehicles of ministers, bureaucrates and HNW people run in India at the cost of the exchequer. And till such times, the RBI Governor Zindabad,since that day will be beyond his tenure.
    If the flood of dollars is utilized towards productive ends having more returns than the cost of foreign currency leading to leverage of our exports or towards import substitution, we will emerge as winners
    all depends upon the way we play the game.

    • Leo says:

      IT is not going to do anything mark my wors it is making things worse …when u have rates rising these guys will have to pay back more dollors and more interests .
      See the external debt figures it is growing like hell EXTERN debt is 390 billion which was 150 billion in 2008 2009
      60 years it took for us to get to 100 150 billion it has doubled…what it means these people doubled the problems ( doubled money supply to get gdp to 9% but the effect velocity is tanking 50% in 30 years so net gdp is like 4%
      MV = GDP
      now 3 year lock in right with rates moving higher ? if i had dollors i would not give to indian banks at 3,5% if i see my normal rates rising to 5 % in quick time .
      So lets see what happens

  • Punit says:

    Dear All,
    I represent a reputed private bank in India. To inform you all, we are currently doing the above product discussed(ie FCNR Forward swap in USD). The current simple average returns are to the tune of 14% per annum(Simple average yield for a tenure of 5 years).
    Kindly call me on +919819067893 for more details.