Recent RBI steps in September to stop rupee depreciation have created a new buzz in the banking sector in attracting NRI funds, this time in Foreign Currency Non Resident (FCNR) deposits, especially, through Leveraged FCNR deposits. Exploiting the opportunity, it is expected that banks could raise USD 10 billion or more. A lot of banks such as ICICI, HDFC, Kotak, Axis, Yes, Deutsche, DBS, Federal, Standard Chartered, etc. are in final stages of launching or have already launched the product.
How this works:
NRI would get loan of 9-10 times or even 19-20 times on his investment at lower rates and total amount, together with loan, is invested in FCNR deposits with bank in India earning higher interest. While there could be numerous ways, I have explained two as follows:
- FCNR deposit account is opened with a bank in India. The bank immediately marks lien on the FCNR FD and affiliated foreign bank offers the customer a loan against the deposit. The customer uses the loan again to create another FCNR deposit, and again foreign affiliate bank gives loan. The process is repeated 9-10 times.
- The customer opens an account with a foreign bank, against which loan of 9 times is given. The total amount (principal + 9 times loan) is invested in the FCNR deposit with the affiliated bank in India and then given as a security for the loan.
The result would be significantly higher return on investment (return on principal + interest arbitrage on 9 or 19 times of loan amount).
Why Indian Banks are interested Now?
The RBI through press release on September 4, 2013 and notification on September 6, 2013 announced that banks can swap dollars raised through FCNR deposits at a fixed rate of 3.5% per year under a special window until November 30, 2013 only. The swap rate in the market was around 7%. Higher Swap rates restricted Banks from aggressively marketing FCNR deposits.
With lower swap rate and high INR interest rate, FCNR deposits have suddenly became attractive for banks. Now, banks sell dollars to RBI for rupees (at the time of deposit) and simultaneously enter into an agreement to buy dollars at a future date (maturity of loan) at a premium of 3.5% significantly reducing the cost of funds.
Indian bank vs. Foreign Bank:
While the facility is available to all banks, it is largely foreign banks and banks with significant overseas presence that are be able to draw in funds. Banks with only Indian operations have also entered into agreement with foreign banks to provide this product. Usually, processing charges may be higher in foreign banks.
Awesome, Amazing, Exceptional return on FCNR deposits with Banks that could go upto 12-20%+ TAX FREE in India without currency Risk.
When investment options that are too good to be true are available, it is very important to analyze and understand various risks associated with such investments. While there could be more risks, I have identified and analyzed following risks:
- The primary risk is the credit risk that the bank where you invested in FCNR deposit would not pay at maturity and will go bust. However, you will be personally liable to pay off the loan.
- Fixed vs. Flexible rates: You will get fixed return on your FCNR deposits. You have to be careful to see if the interest on the loan amount is fixed or variable. If your loan interest rate is flexible (based on LIBOR), you have an additional risk that the LIBOR could go up.
- Processing fees: The Banks charge between 1% and 3% of processing fees upfront, which reduces your return. You could negotiate with the banks to lower the fees.
- Amount of leverage: If you could get only 8-10 times your investment, your return would be significantly lower than someone who could get 19-20 times the leverage.
- Over leverage: It could result in exponential leverage. It started with 8-9 times few months ago and now banks are ready to give loan of 19-20 times. It could also increase to 100 times or even 1000 times. The question you got to ask is where will it end and who till pay or whether the bank where you invest have enough resources or means to earn more than what they pay you.
- Tax and other Compliances: While the FCNR deposits are tax free in India, NRIs may be liable to pay the tax based on the tax laws of their resident countries. For example, US residents will have to pay tax on FCNR deposits whereas resident of middle east or tax heaven countries may not have to pay tax. US residents also have to understand and comply with the Foreign Account Tax Compliance Act (FATCA) as well as FBAR requirement of Department of Treasury.
- Decreasing Interest Rates: The effective cost of FCNR deposits to bank of 3 years in USD is FCNR deposit rate of 4.95% plus 3.5% of hedging cost i.e. 8.45%. Currently the interest rates are higher. What if the interest rates falls and rupee funds are available at cheaper rates or what if banks may not be able to invest and get the 8.5% they need to break-even.
- Falling rupee: If the rupee depreciates to 70/$ from 60/$. The interest cost of the bank would also increase from 2.97 lakhs to 3.47 lakhs for $100,000 FCNR deposit (Interest of $ 4,950).
- Sovereign or Currency Risk: India, as a country is taking a huge risk as the government assumes the rupee will appreciate or will depreciate marginally. When the benchmark one-year forward USD/INR premium was around 7%, RBI is selling the forward at 3.5% premium. This increases the sovereign risk. If the exchange rate increases to 80/$, Banks will be okay as they had already hedged their risk by entering into swap with the RBI at 3.5% premium, but how RBI will address the risk would remain to be seen. This is just a temporary solution to current Indian crisis. The leveraged money could leave as quickly as it has arrived resulting in currency depreciation. In such a case, it would not be just the FCNR deposits but all deposits would be at risk. I would say INR deposits (NRE FD) would be a higher risk as RBI would allow rupee to depreciate, negatively affecting returns on INR (NRE) deposits.
- Other Risks:
- Risk of premature withdrawal and related risk to investor (penalty) or to bank (unwinding of forward)
- Capital Controls at time of withdrawal – While FNCR deposits can be freely repatriated now, what if RBI restricts the FCNR funds to be repatriated at maturity?
There is no free lunch. Every investment has risk. For investments that offer higher return has higher risks. If you are ready to take the risks related to the leveraged FCNR deposits, it offers an amazing return. However, I think, these risks would fall under the “Low to medium risk” category looking at the current market scenario and the backing of RBI and Indian Government.
As a general view, I would recommend such investments as it provide higher risk adjusted return. However, amount of leverage, processing fees, selection of banks, relationship or liaison with senior bank personnel, and taxation or legal compliance would be key.
Please note that the suitability of the investment varies and needs to be checked and analyzed independently for respective NRI investors. The views are personal and shared for general information purposes only and not to be termed as offer or advice. We are not responsible for any action or interpretation and you are requested to contact your bank, financial advisor or legal advisor before making any decision.
If you have any question or comments about the product or bank, please let me know and I will be happy to guide you in the best possible way.