MUMBAI: Reserve Bank of India has opened the floodgates for foreign capital, allowing Indian banks to route money from overseas branches to non-resident Indians for deposits back home under a revamped FCNR(B) scheme, while also removing key currency and credit risks to spur inflows.The second dispensation that will have a multiplier effect on NRI deposits is the permission granted to Indian banks to eliminate the credit risk for overseas lenders. Banks have been allowed to issue a standby letter of credit in favour of overseas lenders against FCNR(B) deposits. The chances of an NRI defaulting on loans taken against FCNR(B) deposits are minimal, as this standby letter of credit guarantees repayment to the offshore bank that has lent against the outstanding deposits. This clarification was provided by the RBI through a frequently asked questions (FAQ) document issued over a fortnight after it announced the special FCNR(B) deposit scheme, under which it undertook to swap forex deposits into rupees and back into foreign currency at the time of maturity.RBI has also said that the free forex hedge is only on the principal deposit and not interest that banks pay out.
The math relies entirely on a positive interest rate spread. Because RBI’s special swap window absorbs the currency hedging costs for fresh 3-to-5-year tenors, Indian banks can aggressively price FCNR(B) deposits at attractive fixed rates of 6% to 7%. If an overseas investor can borrow funds internationally at a lower floating rate (eg, 5-5.5%), they pocket the difference on the massive leveraged portion. On paper, this leverage can theoretically amplify a standard 6% fixed-income dollar yield into double-digit returns (often marketed anywhere between 12% to 19%).Among other clarifications, the RBI said that it will swap deposits booked under the scheme that have a residual maturity of less than three years, and not “at least three years” as proposed earlier.Banks have been allowed to offer differential interest rates to customers, but only based on two parameters: the tenor of the deposit and the size of the deposit. They cannot arbitrarily offer preferential rates. Meanwhile, banks are not required to use the new RBI swap facility for every 3-to-5-year deposit they mobilise. They can continue offering conventional foreign currency deposits without a mandatory one-year lock-in.
