This is done indirectly by lending FCNR(B) funds to their overseas branches who, in turn, invest in Indian corporate papers. The Reserve Bank of India rules on FCNR(B) funds do not allow investment in overseas corporate debt. Banks are allowed to invest their FCNR(B) funds only in US Treasuries and other highly liquid investment avenues, including inter-bank market.

However. banks can freely lend their FCNR(B) funds to their own overseas branches as it will come under inter-bank lending, which is permitted. A Reserve Bank of India official admitted that the restriction is only on deployment of FCNR (b) funds, but the overseas branches ofthese banks are free to invest as they feel even if they are borrowing the parents' FCNR (B) funds. The foreign branches of Indian banks are free of any investment restrictions as they operate under the banking laws of the host countries.

However, not all Indian banks are sure about utilising this route. "We are just booking losses on our FCNR (B) funds. I don't think investing in high yielding overseas Indian corporate paper through our foreign branches is a good idea. This goes against the spirit of the rule, which ensures that FCNR (B) funds are invested in highly liquid and low risk investments," said the treasury head of a leading public sector bank.

Indian banks lend their FCNR (B) funds to own branches at interest rates that are higher than the overseas market rates and at the same time competitive enough to cover the historical cost of these funds.

The average cost of FCNR (B) funds are in the region of 5.50 -- 6.00 per cent, while the prevailing return on investment in US treasuries and in theinter-bank market abroad is lower at around 5.00 per cent. The six month London inter bank borrowing rate (LIBOR) has been hovering just above 5 per cent in recent weeks compared to the near 6 per cent even six months back. The US Federal Reserve had last week cut its fund rate, which banks charge each other on overnight loans, by 25 basis points to 5.25 per cent. The expectation in the global money markets is for the interest rate to fall further.

According to bankers, any more rate cuts by Federal Reserve will further worsen the situation for Indian banks. The banks have already dropped their FCNR (B) deposit rates drastically over the last one month and are expected to lower it further. Bank of India has lowered its six month FCNR (B) deposit rates to 4.75 per cent from about 5.75 per cent a little more than a month back.

But the new rates are applicable only for the incremental deposits, which in any case has not been growing since the last couple of months. The historical cost is much higher. Whilelast year, Indian banks were deploying a large part of these funds in extending lucrative dollar denominated loans to domestic companies, that avenue has almost closed with the high forward premium and uncertainty on the exchange rate. According to bank sources, in the best case scenario, banks will have about 50 per cent of their funds deployed in the lucrative FCNR (B) loans extended to Indian corporates that has forex earnings or other natural hedge against depreciating rupee. The rest of the FCNR (B) funds, have no other choice but to be invested in safe low yielding government securities and inter bank borrowing abroad.

But the banks are trying to make the best out of the situation by booking loss on their FCNR (B) loans, and gaining a huge profit by their investment in Indian corporate debt abroad, which are available at large discounts of 5 to 20 per cent discount to their face value. Since the low valuation of Indian papers are due to the increasing emerging market risk perception, these bankbranches are able to pick up good Indian papers at large discounts. This include listed Indian corporate bonds as well as even plain vanilla loans of such Indian blue chip companies as Reliance, ICICI, Telco, NTPC etc.