Leveraged NRIs on returns trip may fuel FCNR inflows

Written by Aparna Iyer | Mumbai | Updated: Sep 12 2013, 04:36am hrs
While the Reserve Bank of India (RBI) has offered banks concessions to help them attract dollar flows, the biggest chunk of funds is expected to come in through arrangements where banks will first borrow in the market and then loan the money to non-resident Indians (NRIs), who in turn will park the money in long-term foreign currency non-resident (FCNR-B) deposit products.

Analysts, who had forecast inflows of around $10 billion thanks to the RBIs swap facility, believe inflows could be stronger if clients use leverage to park money in FCNR products. At the end of July, outstanding FCNR deposits were $15.4 billion, data from the RBI showed, a marginal increase over $14.3 billion at the end of July 2012.

Depending on the NRI customers ability to leverage which bankers say could be 18-19 times he could earn effective returns of up to 20% on his investment. In a typical leverage arrangement, the bank may ask the NRI customer to draw a dollar loan at a spread, over Libor of, say, 1-2% and then park these funds at an interest rate of around 4-5% in FCNR deposits with a maturity of three years or above. The tenure of the loan would match that of the FCNR deposits. Therefore, on average, he would earn a return of 2-3% or even more on the leveraged portion, but effective returns on his investment could be much higher. The interest rate on FCNR deposits is capped at 400 bps above Libor; most banks offer the maximum rate.

By way of a special swap facility the RBI announced last week, banks can get rupees for the dollars raised through FCNR deposits at a fixed swap rate of 3.5%.

In other words, banks sell dollars to RBI for rupees and simultaneously enter into an agreement to buy dollars at a future date at a premium of 3.5%. In the market, banks will have to otherwise pay 7% as premium which is the current swap rate. The high swap rate had deterred banks from marketing FCNR deposits aggressively.

Senior foreign bankers confirmed they have started approaching NRIs while some Indian banks too are tying up with other foreign banks to provide leverage to their customers.

Large Indian banks like SBI, ICICI Bank and Axis Bank would tie up with other large foreign banks and guarantee the loans given to NRIs, which are in turn deposited in the FCNR accounts of the Indian banks, said a senior official at a mid-sized private bank. People even borrow money and bring into deposits. Through this, some lending also happens for the bank; some big banks are doing this, said A Surendran, head-retail and international business, Federal Bank.

Since FCNR deposits come under private banking products, offering leverage with the package is an ongoing practice, they said.

Given the prevailing forward premiums and the FCNR pricing, no bank was interested in marketing these deposits. The RBI has addressed this situation through the swap, said the head of treasury at a foreign bank. The benchmark one-year forward dollar/rupee premium was around 7.5%.

The bank sees a growth in its business, both on the deposits and the loan book. Such leverages can be cross-border as well, bankers said. Both the bank and the NRI customer bear the cross-border risk.

The RBI announced last week that banks can swap dollars raised through FCNR deposits with it at a rate of 3.5% under a special window. The swap rate in the market is around 6-7%, bankers said. While the facility is available to all banks, it is largely foreign banks and banks with significant overseas presence who will be able to draw in funds, say bankers.

Foreign banks are better placed to do this because they can leverage it in a better way. Even Indian banks that have large branch networks overseas can offer this leverage, said an official at a private bank.

Foreign banks also stand to benefit in terms of cost of funds. Since foreign banks don't have a large retail deposit franchise and borrowings from the RBI's liquidity adjustment facility has been capped, they have been forced to borrow funds from the Marginal Standing Facility (marginal standing facility) at 10.25%.

The FCNR scheme will allow them to raise cheaper funds offshore and deploy them onshore, say experts. Public sector banks, however, may not be enthused to push FCNR deposits as domestic retail deposits may still prove to be cheaper. PSU banks may not be very enthusiastic. Foreign banks would be happy as otherwise, they access rupee funds at 10.25% from the MSF, said Partha Bhattacharyya, deputy CEO, Mecklai Financial.