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Fixed Income

The Low Risk NRI Mega Return Through Leveraged FCNR Deposits

Foreign banks are now rushing to fund Non Resident Indians who can invest the money into Indian dollar deposits under the FCNR scheme. The RBI has reduced the hedging cost of the FCNR deposit to 3.5%. (This applies for a 3-5 year term)

So the banks that offer about 5% in dollar terms. will have to earn about 8.5% which is a low cost of funds.

This can be hugely profitable if you are an NRI. Let us say you can borrow for 3 years on a balloon payment basis at 4% fixed rate. (that is, you get to pay only interest on the loan for therand then all the principal at the end) You borrow $200,000 against, say, a car or house and put it into an FCNR deposit with a bank in India at 4.95% for three years.

You will get an interest of $9,900 in year 1. And then, you must pay out $8,000 to your bank, and you keep the remaining $1,900. There is low risk of rupee drop or such because the 4.95% is guaranteed.

The return is magnified by the leverage. Assume you put in $50,000 in the same above scheme. Your return will be $2,475 on your own money plus the $1,900 you make on the borrowing (net). A return of about $4,375 on a 50K capital, which is more than 8% – a great return in dollar terms.

Of course, you do risk that the bank goes bust, but hey, one’s gotta take risks no?

There is a risk that US residents face a complicated tax regime (FCNR proceeds are not taxed in India, but they will be in the US). But residents in the middle east don’t have to deal with that.

Another risk is: falling Indian interest rates. If rates were to fall, a bank may not be able to invest and get the 8.5% they need to break even. This too is a low risk.

The last risk is: the rupee goes back to 75 from today’s 62. The NRI that invested $100,000 will get the bank Rs.6.2 million (62 lakh) today at a rate of Rs. 62. In a year, the bank needs to pay interest of Rs. 306,000 at a conversion rate of 62 (4.95% interest rate). But at Rs. 75 to a dollar, they may pay Rs. 371,000. That means their 62 lakh rupees should now earn at least 6% interest and including then the hedge cost of 9.5%!

Overall, this is a nice financing scheme for banks. The FCNR deposit gives them rupees at an effective rate of 8.5% (most banks are at this rate effectively, offering about 5% for a three year deposit and including the hedge cost of 3.5%).

But it’s a great return for the NRI – and with banks creating loan products to fund the exposure, this is going to take off in a big way. However, leverage always has a downside we can’t imagine today – I wonder what the catch is here.

  • mangoman2012 says:

    Deepak,
    as I see it, RBI is taking currency risk and it thinks that Rupee will appreciate when the deposits mature.
    Raghu may think that he can reset the economy before the deposits matures. I have the following questions…
    1. Will the existing FCNR deposits will come as new FCNR in disguise to take advantage of the scheme ( premature renewal)
    2. What if Rupee depreciates further from here thus making RBI to bear huge losses..It is a possibility that our corporates cannot turn over night goodies…money collected through this fCNR again will go back to Real Estate through banks..our netas will support this..
    What do you think?
    But finally I think, the people who deposit may not lose anything but currency will depreciate more as this is also some kind of soverign bond and one of the reason I think the currency will depreciate is Equity exodus in near future

  • Leo says:

    THis is an assumption SOvreign panic wont happen THAT Is RATES wont rise In us UK EUROPE JAPAN…
    Sowing the seeds for a blow up ..i would say …

  • XYZ says:

    Don’t you guys get it? Rajan has already telexed his intentioned. He is going to keep rates high to follow a hard currency policy. Most probably it will start after the elections. Expect a lot of economic pain, a recession and even political problems.
    That’s what the Chicago Boys do. Though to be more accurate, Rajan is from the lesser Booth School.

  • Krish says:

    Deepak, you got my attention like a hell with this article. It got my rapt focus as am a NRI from Middle East. Let me give feedback from the groundlevel about this potential opportunity highlighted in your article.
    99% of the NRIs in MiddleEast are low wage earners (less than $ 1000). Now we will talk about cream of 1% who are mostly double income NRIs (employed couple). 99% of this 1% cream had already taken loan from the local banks in Gulf for following reasons:
    1. Buying a propery in India
    2. Family expenses (marriage, children, medical and so on)
    3. Buying property in Middle East (some countries such as Dubai, Oman and Bahrain allow this)
    4. Converted to INR already as they saw it attractive rate for the last couple of months or last year. I know lot of people had taken loans just because they are getting attractive exchange.
    Take statistics from all the banks of India. FCNR deposits from the ME would be lowest. Getting a loan of nearly quarter million USD from the gulf local banks is beyond the capacity of many working class here. The capable guys number is tiny and would not go beyond 4 digits. Even this tiny number must have already committed to loan for the reasons highlighted here.
    One last point. By the way many of the banks in Gulf offers loans upwards of 5% interest rates. Even without taxation, I don’t think investor has any NIM through this leverage option. The banker here often redicules me as the only person who refused to take loan inspite of several offers.
    This RBI move is like virtual food and would not fill the stomachs. I believe, zero dollars would move in to India to take advantage of this decision. I don’t see any adv. But it would be a talking point for markets, media and blogs.

  • MS says:

    i don’t agree with mangoman. RBI is not taking any currency risk. If RBI offers a swap to the bank, its also does a back to back hedge with another counterparty. It cannot keep such a large open/naked position. Though that hedge would be in line with the current market rates, RBI is ready to bear that loss to stabilise exchange rates, which more vital to health of system than a loss of a few million dollars.

  • Scorpio says:

    Some banks in Middle East have struck gold with this scheme, people are leveraging as much as 19times on customer equity. Banks are charging up-to 2 % upfront structuring fees – so if you invest about 100K ( which is minimum) – banks makes straight 38K as upfront fees which the customer needs to pay. Adding the diff between the loan interest and interest earned – customer makes about 14%-15% return and bank also makes a killing. Who is losing ! I am sure Indian bank receiving money is not losing

  • Leo says:

    ThE whole idea of leverage is 3 years…i dont think banks which are lending money understand this…. more leverage …it always goes exponential…
    i will give u one example say rates go to 5% … these guys have to give back the dollors they borrowed…
    The unwinding will be so fast … u wont be able to react and blink so it creates massive deflationary outcome… which is good for shorters like me who will know when lightening can strike and make a killing…THE GAME OF MONEY SUPPLY CAN CREATE BOOMS *bubbles but they are sowing the seeds for massive run on institutions….and that is why people buy gold…coz they dont want to punt on it…….WELCOME TO THE NEW NORMAL…

  • sachin says:

    Can you please explain this part “The return is magnified by the leverage. Assume you put in $50,000 in the same above scheme. Your return will be $2,475 on your own money plus the $1,900 you make on the borrowing (net). A return of about $4,375 on a 50K capital, which is more than 8% – a great return in dollar terms.”