Leveraged product for the NRIs

If you are an NRI then you just got richer !!!!

When the Ryan Gosling (Raghuram Rajan) of Indian politics took centre stage as RBI governor he announced a scheme that made richer NRIs even richer and quenched the domestic USD demand temporarily.

RBI has been liberalizing regulations around FCNR deposits to shore up USD flows which are more stable in nature. It first increased the FCNR rates from L+300bps to L+400 bps. Second, removed CRR and SLR requirements on FCNR and NRE deposits and third, opened a USD to INR swap window on fresh FCNR  funds mobilised (with minimum maturity of 3 years) with RBI @ 3.50%.

With this came the introduction of the leveraged product.

Explained as below:

Mr. A (HN-NRI)      
Deposits as security USD 1.00 mio with offshore branch of bank A for the purpose of availing FCY loan

Bank A                      
Keeping this deposit of USD 1.00 mio , lends to Mr. A USD 15 mio

Mr. A      
Deposits USD 16 mio as FCNR deposit with the India branch of Bank A

Bank A borrows from market @ L + 200

Lends to client @ L+300

Client A makes a 5 year FCNR deposit at the Indian branch of Bank A @ L + 400

Client earns a staggering 19% p.a. return on a USD deposit of USD 1 mio. (1% on USD 15 mio and 4% on USD 1 mio). Now this return depends on the spread between loan to NRI client and FCNR deposit

Bank swaps the principal of FCNR deposit with RBI @ 3.50%, thereby generating INR funds at L+200 bps-L-300 bps +L+400 bps+350 bps   = L +650 bps

The rupee funds so generated are further lent to Indian corporate at say @ 11%

Since the returns on USD deposits are to be repatriated semi annually there is a currency risk on the interest portion of the deposit. In the above  example , USD 95000 needs to be repatriated s.a.. If the entire system is to receive an FCNR deposit of USD 10 bn then the system is exposed to a currency risk of USD 125 mn (assuming a spread of 100 bps over USD loan and leverage multiple of 16 times - 10bn * 1% and 4% on USD 10bn/16 ). The same can be hedged by doing a USD to INR Coupon only swap. 

This product has multiple benefits:

Increases the balance sheet size and the income of the offshore branch
Considerably increases the FCNR deposit base and improves the NIM of the onshore branch
There is no credit risk as the client’s deposit is used as a security to lend funds which are in turn deployed by the same banks onshore branch. However, care must be taken that there is no premature withdrawal of the FCNR deposit.

I have tried to explain the product to the best of my understanding !!! Would appreciate any inputs ..... x