Indian banks to absorb extra 15-20 bps cost on FCNR(B) deposits due to interest-rate hedging
Banks in India will incur an additional 15-20 basis points on FCNR(B) deposits because the Reserve Bank of India only hedges the principal, leaving interest-payment exposure to be covered by the banks themselves.
Banks attracted $127 billion through the RBI’s concessional swap window for FCNR(B) deposits, but the central bank’s swap facility only covered the principal amount, not the interest payable. As a result, banks must independently hedge the dollar exposure on interest, which treasury officials say will raise the effective cost of these deposits by about 15-20 basis points. For a 6.5% offered rate, the true cost could be 6.65-6.70%.
Some institutions have left a portion of the interest exposure unhedged, risking higher rupee costs if the rupee falls further, while others are using forwards despite rising premiums. The surge in dollar deposits has also strained the RBI’s liquidity management, prompting a series of open-market operations slated for mid-September and the continued use of variable-rate reverse repo facilities. QuantEco Research estimates these measures could soak up roughly Rs 10 trillion of excess liquidity, leaving limited scope for additional sterilisation tools.
Why it matters
Higher hedging costs will raise borrowing expenses for Indian banks and could affect rates offered to NRI depositors.
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