FCNR-B flows taper as higher costs trip math for double-digit returns

Mumbai: The pace of garnering special foreign currency (FCNR-B) deposits by Indian banks appears to have slowed after an enthusiastic start, bankers said, as high-networth overseas Indians seek double-digit dollar returns and assess some tax implications on the instruments. Overseas borrowing costs, meanwhile, have caused a rethink for banks on the amount of leverage they can offer clients.

"The issue is the pricing of dollar funds, which is key to ensuring that high net worth individuals (HNIs) get enough leverage on their funds that will ultimately lead to double-digit returns," said a banker aware of the situation. "But dollar funds - both on bonds and loans - have been more expensive as foreign banks are seeking a higher price. So, what was available at 100 basis points above the benchmark rate is now costing 150 basis points over the benchmark rates, which have skewed the calculations."

One basis point is a hundredth of a percentage point.


Hence, Indian banks with overseas branches are still fine-tuning their deposit mobilisation strategy under the special programme, even as chunky inflows are yet to come in a month after the Reserve Bank of India (RBI) published guidelines for garnering the three- and five-year deposits with a hedging backstop provided by the regulator.

The success of the programme is based on how much banks can borrow abroad and lend to their HNI clients.

The Leverage Math

Banks could offer up to nine times leverage on a $1 million deposit, promising them a 14.08% yield on deposits after leverage, compared with the upfront offer of a 6% dollar-based interest on a five-year lock-in.

To a potential client with $1 million in ready cash in the US, a New York branch of an Indian bank can lend $9 million to this person, allowing her to leverage her deposit nine times. That means she now has $10 million in FCNR (B) deposits.

If the branch has borrowed the money at 5% overseas and lends to this client at 5.5%, the branch makes 0.5% in profits. This client brings the money to India and deposits it as a FCNR (B) at 6%, which means she is also making half a percentage point more by borrowing the funds.

If the leverage is extrapolated over a five-year period, the client earns 6% on her own $1 million and 0.5% on the rest of $9 million, which could give her 14% returns over a three-year period. But overseas rates have spiked, forcing Indian banks to recalibrate their plans.

State Bank of India (SBI) and Bank of Baroda (BoB) had to pull back their dollar bond issues last month because investors demanded a higher spread over the benchmark US treasury, noting the huge supply from India.

Overseas investors have raised their price expectations ever since HDFC Bank raised $750 million by selling five-year bonds to overseas investors priced at 90 basis points above the five-year US treasury, the tightest spread over the US benchmark for any private sector bank in India.