FCNR(B) deposits emerge as cheaper funding source for banks: BofA

Foreign Currency Non-Resident (Bank) or FCNR(B) deposits have emerged as a significantly cheaper source of funding for Indian banks under the current design of the scheme, according to a research note by Bank of America (BofA) Securities Research.

“Typically, banks would raise 3-5 year deposits at present at around 6.5%-7.5%. By most term sheets we have seen, larger banks have offered interest rates mostly between 5.25%-6% on their foreign currency deposits and with the FX risk being borne by the RBI, for banks, technically the FCNR (B) become a much cheaper source of funding, than conventional rupee deposits will be, especially when compared to CD rates,” BofA Securities said in a research note released on September 8.

Another advantage for banks is that FCNR(B) deposits are exempt from cash reserve ratio (CRR) and statutory liquidity ratio (SLR) requirements. This frees up a larger portion of the funds for lending, making the deposits particularly attractive from a banking perspective, BofA said.

The RBI mobilised around $127 billion in deposits from non-resident Indians (NRIs) through major Indian commercial banks, significantly exceeding its initial target of about $50 billion.

The strong response prompted banks to raise the funds much faster than initially anticipated. The scheme was subsequently closed on August 31, ahead of the original September 30 deadline.

While the RBI bears the cost of hedging the foreign-currency exposure, BofA estimates that the central bank could earn around 4.5%-5% on the foreign reserves generated through the deposits. This, the brokerage said, could more than offset the hedging cost of up to 3%, assuming the foreign-currency holdings are hedged for five years.

FCNR(B) deposits may stay put

BofA also challenged the view that FCNR(B) deposits would completely reverse once they mature.

The brokerage pointed to the previous FCNR(B) scheme, whose deposits matured in 2016. According to BofA, the earlier experience showed that a portion of the funds remained within the banking system, even after maturity.

“Even in 2016, when the previous FCNR(B) deposits had matured, we did see some increase in NRE deposits, along with a shallower fall in deposits, which rose from $15 billion in August 2013 to $39.3 billion in November 2013, and on the reversal, fell to about $21 billion in 2016, thus still keeping a quarter of the deposits in the system,” BofA said.