FCNR(B) deposits: Understanding who finally bears the foreign exchange risk

Why in the News

The Reserve Bank of India (RBI) opened a special swap facility in June to draw money from non resident Indians into FCNR(B) deposits. The full name is Foreign Currency Non Resident (Bank), and such a deposit is held and repaid in foreign currency rather than in rupees. The step answered pressure on the rupee from high oil prices and an aim of building up foreign exchange reserves. The facility protects banks against exchange rate loss on the principal. It does not cover the interest, which is owed in dollars and has to be arranged by the banks themselves. That split is what decides who finally carries the currency risk.

What is an FCNR(B) deposit and what did the special swap facility offer?

1. A deposit denominated in foreign currency: A non resident places dollars or another permitted currency with an Indian bank, and the bank repays in that same currency, so the depositor carries no rupee risk.
2. The term of the money: These deposits typically run for three to five years, which is when the principal and the accumulated interest fall due.
3. What the swap added: The bank passes the foreign currency to the central bank for rupees and receives a commitment to reverse the exchange at an agreed rate on maturity.
4. The window is shut: Fresh deposits under the facility stopped on 31 August 2026.

Why was the window opened, and what did it actually raise?

1. The response overshot the target: Banks mobilised more than $127 billion through these deposits against an initial target of about $50 billion.
2. Funding turned cheap: The scheme gave banks foreign currency at a lower cost than borrowing abroad on their own credit would have carried.
3. Reserves rose with it: The foreign currency handed to the central bank added substantially to India’s reserve stock.

What does protecting the principal cost the central bank?

1. The hedging bill sits with the central bank: It bears the cost of covering the currency exposure on the principal, put at up to 3% a year by BofA Securities Research and taken at about 3% a year by SBI Research.
2. The annual and cumulative numbers: On an assumed mobilisation of $65 billion to $70 billion at that rate, SBI Research calculated a notional cost of about $2.1 billion a year and about $10.5 billion over five years.
3. Measured against the reserve stock: Against reserves of around $700 billion, the five year cost works out to 1.45% of the stock.

What offsets that cost?

1. The reserves themselves earn a return: BofA Securities Research estimated a yield of around 4.5% to 5% on the reserves generated, enough to more than cover the hedging cost across a five year holding.
2. Placement is chosen for yield: Part of the money may be invested in United States government securities because those yields are higher.
3. Part of the outgo is already recovered: SBI Research said the central bank had rebuilt $31.2 billion of its foreign currency assets by 7 August 2026, equal to 55% of the amount mobilised to that point.

Why have most banks left the interest leg unhedged?

1. The swap stops at the principal: Banks have to source the dollars for interest payments and manage that exposure on their own books.
2. The split runs by ownership type: Foreign banks are largely hedging this exposure. Most state run banks and several private sector Indian lenders have left it open.
3. Cost is the stated reason: Bankers cite the price of cover on a three to five year exposure, which is of the same order as the cost the central bank carries on the principal.
4. The payment timing invites the gamble: Interest on these deposits is paid only at maturity, so some banks plan to buy dollars in the spot market when the payment actually falls due.

What happens to an unhedged bank if the rupee weakens?

1. The arithmetic of one payment: Interest of $1 million costs Rs 9.5 crore at Rs 95 to the dollar, and Rs 10 crore if the dollar reaches Rs 100 at maturity.
2. Cover decides who absorbs it: A hedged bank is protected against that movement, and a lender that left the exposure open bears the higher rupee cost.
3. The risk is correlated across lenders: A sharp fall in the rupee would push many banks to buy dollars at the same time, adding to dollar demand and to pressure on the currency.
4. The exposure has not gone away: The scheme moved currency risk between parties rather than removing it from the system.

Challenges to the FCNR(B) swap route to reserve building

1. Reserves built this way are borrowed reserves: Non resident deposits count within India’s external debt, so the reserve stock rises with a matching liability against it. Eg. Non resident deposits are among the largest components in the Finance Ministry’s quarterly external debt statement.
   The Fix: Publish the debt creating share of any reserve addition alongside the headline reserve figure.
2. Maturities bunch at one point in time: A window opened over a single quarter falls due over a single quarter, which concentrates the outflow. Eg. The concessional swap window of 2013 raised about $34 billion and came up for redemption together in late 2016.
   The Fix: Stagger the maturities permitted under a window across quarters rather than letting the market settle on one tenor.
3. The open exposure sits with the thinnest buffers: Public sector lenders hold less capital against a valuation loss than the foreign banks that are covering the same risk. Eg. Several public sector banks required recapitalisation from the Union Budget through the second half of the 2010s.
   The Fix: Set a supervisory ceiling on the share of foreign currency interest liability a bank may leave uncovered.
4. The facility substitutes for adjustment: Attracting deposits to steady the currency postpones the correction that a persistent current account gap eventually forces. Eg. The rupee continued to depreciate through the years after the 2013 defence of the currency ended.
   The Fix: Tie any such window to a stated reserve adequacy target, so it closes as a one time step instead of becoming a standing instrument.

Conclusion

The swap changed the address of the currency risk without retiring it. The central bank now holds an exposure that depositors were unwilling to take, and lenders hold the portion the central bank declined. Whether that is prudent rests on a rupee path nobody can commit to. The supervisory question to watch is whether banks will be required to cover the foreign currency leg they have chosen to leave open.

Back2Basics: Non resident deposit accounts

1. NRE account: A Non Resident External account is held in rupees, and both principal and interest are freely repatriable.
2. NRO account: A Non Resident Ordinary account is held in rupees for income earned in India, and repatriation out of it is capped.
3. Where the currency risk sits: In a rupee denominated non resident account the depositor bears the exchange risk, which is the reverse of a foreign currency denominated account.

Matching Previous Year Question

“[2019] Consider the following statements: 1. Most of India’s external debt is owed by governmental entities. 2. All of India’s external debt is denominated in US dollars. Which of the statements given above is / are correct? (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2 ANSWER: (d)”