Why in the News?

• Indian banks mobilised over $127 billion through FCNR(B) deposits under a special RBI swap facility, but with the window now closed, attention has turned to who bears the foreign exchange risk on the principal and interest.

What’s in Today’s Article?

• About FCNR Deposits (Meaning, Special Swap Facility, Risk Management, RBI’s Cost-Benefit Position, Exposure Among Banks, Broader Assessment)

About FCNR(B) Deposits

• Foreign Currency Non-Resident (Bank) deposits, or FCNR(B) deposits, are term deposits that non-resident Indians can maintain with Indian banks in foreign currency rather than in rupees.
• The key feature is that both the principal and interest are denominated in foreign currency, typically US dollars.
• This protects the depositor from rupee depreciation, a significant attraction for NRIs who would otherwise see the value of their savings erode if the rupee weakened.
• These deposits are usually held for maturities of one to five years and are a long-standing instrument for attracting foreign currency into India's banking system.

The Special Swap Facility

• The RBI introduced a special swap facility in June 2026 to encourage NRIs to place money in FCNR(B) deposits.
• The context was pressure on the rupee from high oil prices and India's need to strengthen its foreign exchange reserves amid the West Asia conflict.
• Response - the scheme attracted far more than anticipated:
  • Initial target: around $50 billion
  • Actual mobilisation: more than $127 billion
• Given the scale of inflows, the RBI closed the window for fresh FCNR(B) deposits on August 31, 2026.
• For banks, the scheme provided a relatively cheap source of foreign currency funding. For the country, it added substantially to foreign exchange reserves at a time of external pressure.

How the Risk Is Split?

• Because these deposits typically carry three-to-five-year maturities, the question of who bears currency risk when principal and interest fall due becomes important.
• The answer is that the risk has been divided between the central bank and commercial banks.
• The RBI Covers the Principal
  • Under the swap arrangement, the RBI shields banks from foreign exchange risk on the principal amount. The central bank bears the cost of hedging this exposure.
  • Estimates place this hedging cost at up to 3% annually.
  • In simple terms, the RBI is protecting the dollar value of the principal against movements in the rupee-dollar exchange rate, absorbing the cost of that protection itself.
• Banks Handle the Interest
  • The swap facility does not cover the interest that banks must pay depositors in dollars.
  • This means banks have to arrange the dollars themselves for interest payments and manage that foreign exchange exposure independently.

The RBI's Cost-Benefit Position

• The RBI's position is not purely a cost. The foreign currency received through these deposits adds to India's reserves, which can then be invested.
• Recouping Reserves
  • By August 7, 2026, the RBI had recouped $31.2 billion of its foreign currency assets, equivalent to 55% of the amount mobilised at that point.
  • Part of this may be invested in US securities, which offer higher yields.
• Potential Returns
  • Estimates suggest the RBI could earn around 4.5% to 5% on the foreign exchange reserves generated through these deposits.
  • This could more than offset a hedging cost of up to 3%, assuming the foreign currency holdings are hedged for five years.
• The Scale of the Cost
  • Research assuming FCNR(B) mobilisation of $65-70 billion and a 3% annual hedging cost calculated:
    • Annual notional cost: about $2.1 billion
    • Cumulative cost over five years: about $10.5 billion
  • Against current reserves of around $700 billion, this works out to roughly 1.45% of the reserve stock over five years, a modest figure in relative terms.

Unhedged Exposure Among Banks

• Where the risk becomes more concerning is on the interest side.
• Who Is Hedging - pattern varies by type of bank:
  • Foreign banks are largely hedging this exposure.
  • Most state-run banks and several private-sector Indian lenders have left it unhedged.
• Why Banks Are Not Hedging?
  • The main reason cited is cost. Hedging the foreign exchange risk on interest payments for three-to-five-year deposits costs banks about 3% a year.
  • Since interest on these deposits is paid at maturity rather than periodically, some banks have chosen to avoid that cost upfront. Their plan is to buy dollars in the spot market when the payment actually falls due, rather than locking in protection in advance.
  • One banker at a mid-sized state-run lender indicated the bank expected to handle payments through spot purchases when required.

What Happens If the Rupee Weakens?

• The consequences of leaving this exposure unhedged can be illustrated simply.
• Consider a bank that must pay $1 million in interest:
  • If the dollar costs Rs. 95, the payment requires Rs. 9.5 crore.
  • If the rupee weakens and the dollar rises to Rs. 100 at maturity, the same payment requires Rs. 10 crore.
• A bank that has hedged would be protected against this movement. A lender that has left the exposure unhedged absorbs the higher rupee cost directly.

The Broader Assessment

• The FCNR(B) scheme achieved its immediate objective. It brought in substantially more foreign currency than targeted at a time when the rupee was under pressure and reserves needed strengthening.
• The RBI has taken on the exposure associated with the principal through its swap, and appears likely to cover that cost through returns on invested reserves.
• Banks continue to face currency risk on the interest payments, and a substantial share of that exposure remains unhedged by choice.
• This means a portion of the currency risk has been deferred rather than removed, surfacing only when the deposits mature.