Mumbai: Indian banks are racing against time to raise funds before the Reserve Bank of India’s early closure of its foreign currency non-resident bank, or FCNR(B), deposit scheme, but the influx of dollars could leave some lenders scrambling for avenues to deploy them, potentially pushing up borrowing costs, three senior treasury officials said.
The RBI's decision to close the scheme a month early has compressed into a few days transactions that banks had expected to execute over a longer period. So far this week, ICICI Bank, Kotak Mahindra Bank and IDFC First Bank have tapped the offshore market since the RBI announced the closure of the FCNR(B) deposit swap facility on Friday, as banks seek to raise funds and complete deals before the window shuts.
The immediate challenge is deployment. “If some banks have mobilized $6 billion or $7 billion, how do you deploy that much money in two weeks? For a foreign bank, where is the branch network to distribute that much money?,” asked V.R.C. Reddy, treasury head at Karur Vysya Bank, a private lender.
“When the money comes in, banks cannot lend it immediately. Lending takes time and the immediate avenue for deployment is government securities and other AAA-rated instruments, and that is why we have seen the G-sec curve steepen,” Reddy said.
Yield on the 10-year benchmark government bond has risen by five basis points (bps) to 6.82% this week, while those on five- and three-year papers have gone up by 9 bps and 4 bps to 6.45% and 6.21%, respectively.
A handful of market participants also believe that some lenders may run into so-called negative carry, where a bank pays more to raise money than it earns by investing or lending that money. For example, if a bank pays 6.4% on the FCNR deposit and can only invest the resulting rupee liquidity at 6%, it loses money on the spread.
While the immediate challenge remains deployment for several banks, they could use the funds to support loan growth, which has been outpacing deposit growth, and close the funding gap.
The banking system’s credit growth, excluding food credit, rose to ₹219 trillion at the end of July, up 19% from a year ago, RBI data showed. Deposits grew over 15% to ₹269 trillion.
“Some banks may run into negative carry, but not all. It depends on the rate at which they have raised the deposits and where they are able to deploy the funds,” Reddy said.
However, banks such as HSBC or State Bank of India, which had a lower deposit cost of around 5.5%, could still earn a positive spread by investing in government bonds.
“Domestic lenders could replace FCNR(B) funding with bulk deposits and reduce their certificate of deposit issuance. Meanwhile, foreign banks could face some maturity mismatch if they invest the funds in corresponding five-year government securities," Gaura Sengupta, chief economist at IDFC FIRST Bank, said.
An email sent to the RBI seeking response on the matter went unanswered. In an interview to Financial Express on Thursday, governor Sanjay Malhotra said that the RBI expects at least $80 billion through a mix of FCNR, external commercial borrowings (ECB) and overseas foreign currency borrowings (OFCBs).
The sudden influx of FCNR(B) funds could also disrupt pricing in the short-term deposit market, where foreign banks have traditionally been active in the three-month segment.
“Typically, foreign banks used to get deposits in the three-month buckets. Now, if they have got a decent quantum of money, those short-term deposit rates can also get disturbed. The sudden surge by foreign banks will distort a lot of curves,” a senior treasury official at a large private bank said, adding that the impact on short-term deposit rates would need to be watched.
The impact could extend beyond funding costs to banks’ treasury operations. Banks may have entered into swaps and hedges based on an expected volume of FCNR(B) inflows. With the scheme now closing earlier than anticipated, some of those positions could become mismatched.