Source: The Economic Times
Context
The Reserve Bank of India (RBI) has introduced a special dispensation allowing commercial banks to mobilise fresh 3- to 5-year FCNR(B) deposits, with the RBI absorbing the full hedging cost through a special swap window. This is aimed at attracting NRI capital to support the rupee and shore up forex reserves. FCNR(B) deposits are fixed-term foreign currency bank accounts opened in India by NRIs, OCIs, and PIOs, allowing them to retain their savings in foreign currency without rupee depreciation risk. The new scheme uses a 4-step swap mechanism at the FBIL Reference Rate, with interest income tax-free in India and deposits exempt from CRR and SLR.
The FCNR(B) Account in Brief
- Account type: Foreign Currency Non-Resident (Bank) fixed deposit.
- Eligible depositors: NRIs, OCIs, and PIOs.
- Currency: USD, GBP, EUR, JPY, AUD, CAD, and a few others.
- Maturity: 1 to 5 years (current swap scheme focuses on 3 to 5 years).
- Tax: Interest fully exempt from income tax in India.
- CRR and SLR: Fully exempt, so banks can deploy 100 per cent of funds.
- Currency risk: Borne by the bank (since the deposit is in foreign currency), not the depositor.
Aim of the Scheme
- For banks: Provide a stable, large-scale source of low-cost overseas funding to shore up India’s capital account.
- For NRIs: Offer a route to earn tax-free returns in India without rupee depreciation risk.
The 4-Step Swap Mechanism
The RBI’s new swap window works in four clean steps:
- Step 1 (Deposit Inflow): An NRI places foreign currency (USD, GBP, EUR, JPY, AUD, CAD) into the Indian bank as an FCNR(B) deposit.
- Step 2 (Spot Transaction, First Leg): The commercial bank sells these dollars to the RBI once a week in multiples of USD 1 million, at the official daily FBIL Reference Rate.
- Step 3 (Forward Buyback, Second Leg): The bank simultaneously agrees to buy back the same amount of dollars from the RBI at the end of the 3- to 5-year maturity period.
- Step 4 (Concessional Par Pricing): The buyback rate is the same as the first leg (par pricing). This means the RBI absorbs the entire forward premium, eliminating the bank’s operational hedging cost (about 3.5 per cent).
What is the FBIL Reference Rate?
- FBIL (Financial Benchmarks India Private Limited) is India’s benchmark administrator.
- Set up in 2014.
- Jointly owned by FIMMDA, FEDAI, and IBA.
- Regulated by the RBI.
- Publishes official daily reference rates for:
- USD-INR.
- EUR-INR.
- GBP-INR.
- JPY-INR.
- Other currency pairs.
- The FBIL Reference Rate is the default benchmark used in regulatory FX transactions, including the RBI’s FCNR(B) swap window.
Why is the FCNR(B) Window So Strategic?
- India’s NRI diaspora is the largest in the world, about 35 million NRIs and PIOs/OCIs.
- Remittances to India: about USD 138 billion in 2024, the largest globally.
- A focused FCNR(B) push can:
- Bring in significant dollar inflows (USD 40-55 billion expected).
- Stabilise the rupee during periods of stress (FPI outflows, oil shocks).
- Build forex reserves to buffer future shocks.
- Diversify funding sources for Indian banks.
FCNR(B) vs NRE vs NRO at a Glance
| Feature | FCNR(B) | NRE | NRO |
|---|---|---|---|
| Currency | Foreign currency | Indian Rupees | Indian Rupees |
| Repatriability | Fully repatriable | Fully repatriable | Limited (up to USD 1 mn/year) |
| Tax on interest | Tax-free in India | Tax-free in India | Taxable in India |
| Currency risk | Borne by bank | Borne by depositor | Borne by depositor |
| CRR and SLR | Exempt | Subject | Subject |
| Type | Fixed deposit only | Savings and FD | Savings, FD, current |
Key Terms
- FCNR(B) (Foreign Currency Non-Resident Bank): A fixed term deposit in India by NRIs and OCIs in foreign currency, fully repatriable, tax-free, and exempt from CRR and SLR.
- NRI (Non-Resident Indian): An Indian citizen residing abroad for tax or stay-related reasons.
- OCI (Overseas Citizen of India): A foreign citizen of Indian origin granted lifelong visa and certain rights in India (excluding voting).
- PIO (Person of Indian Origin): A foreign citizen of Indian origin, a category largely merged with OCI in 2015.
- Forex Swap: A contract to exchange currencies now and reverse the deal later at a pre-agreed rate.
- Hedging Cost: The cost of protecting against unfavourable currency or interest rate movements.
- Forward Premium: The difference between the forward exchange rate and the spot rate, reflecting interest rate differentials and other factors.
- Par Pricing: A pricing convention where the buyback rate equals the spot rate, neutralising forward premium.
- FBIL (Financial Benchmarks India Private Limited): India’s benchmark administrator, set up in 2014, that publishes daily reference rates.
- CRR (Cash Reserve Ratio): The share of deposits banks must keep with the RBI in cash, currently 3 per cent.
- SLR (Statutory Liquidity Ratio): The share of deposits banks must invest in approved securities (mostly G-secs), currently 18 per cent.
- Net Interest Margin (NIM): The difference between a bank’s interest income and interest expense, as a percentage of interest-earning assets.
Practice MCQs
Q1. With reference to the FCNR(B) account, consider the following statements:
- FCNR(B) accounts can be opened by NRIs, OCIs, and PIOs.
- The deposits are held in foreign currencies like USD, GBP, EUR, JPY, AUD, and CAD.
- Interest earned on FCNR(B) deposits is tax-free in India.
- The depositor bears the rupee depreciation risk on FCNR(B) deposits.
Which of the above are correct?
(a) 1, 2 and 3 only (b) 1, 3 and 4 only (c) 2 and 4 only (d) 1 and 4 only (e) All four
(Statement 4 is wrong; FCNR(B) deposits are held in foreign currency, so the depositor is protected from rupee depreciation risk; the bank bears the currency risk.)
Q2. With reference to the RBI’s new FCNR(B) swap mechanism, consider the following statements:
- The mechanism involves two legs: a spot transaction (first leg) and a forward buyback (second leg) at par pricing.
- The RBI sets the forward buyback rate equal to the spot rate, absorbing the entire forward premium.
- The bank sells dollars to the RBI once a week in multiples of USD 1 million at the official FBIL Reference Rate.
- The bank bears the hedging cost under the new scheme.
How many of the above statements are correct?
(a) Only one (b) Only two (c) Only three (d) All four (e) None
(Statement 4 is wrong; the RBI bears the hedging cost under the new scheme, NOT the bank.)
Q3. With reference to the FBIL Reference Rate, consider the following statements:
- FBIL stands for Financial Benchmarks India Private Limited.
- FBIL is jointly owned by FIMMDA, FEDAI, and IBA, and is regulated by the RBI.
- FBIL publishes official daily reference rates for currency pairs like USD-INR, EUR-INR, GBP-INR, and JPY-INR.
- FBIL is a private foreign agency based in London, with no Indian regulatory oversight.
Which of the above are correct?
(a) 1, 2 and 3 only (b) 1, 3 and 4 only (c) 2 and 4 only (d) 1 and 4 only (e) All four
(Statement 4 is wrong; FBIL is an Indian benchmark administrator, jointly owned by FIMMDA, FEDAI, and IBA, and regulated by the RBI.)
Q4. With reference to NRE, NRO, and FCNR(B) accounts, consider the following statements:
- NRE accounts are rupee-denominated, fully repatriable, and offer tax-free interest in India.
- NRO accounts are rupee-denominated, with taxable interest in India and limited repatriability (up to USD 1 million per year).
- FCNR(B) accounts are foreign currency-denominated, fully repatriable, and exempt from CRR and SLR.
- NRE and NRO accounts also protect the depositor from rupee depreciation, just like FCNR(B) accounts.
Which of the above are correct?
(a) 1, 2 and 3 only (b) 1, 3 and 4 only (c) 2 and 4 only (d) 1 and 4 only (e) All four
(Statement 4 is wrong; only FCNR(B) accounts protect depositors from rupee depreciation; NRE and NRO accounts are held in rupees and expose depositors to rupee risk.)
Answer Key
- (a), Statements 1, 2, 3 are correct; Statement 4 is wrong because the depositor is protected from rupee depreciation risk.
- (c), Statements 1, 2, 3 are correct; Statement 4 is wrong because the RBI bears the hedging cost, not the bank.
- (a), Statements 1, 2, 3 are correct; Statement 4 is wrong because FBIL is an Indian benchmark administrator regulated by the RBI.
- (a), Statements 1, 2, 3 are correct; Statement 4 is wrong because only FCNR(B) accounts protect depositors from rupee depreciation.
