RBI’s OFCB Swap Facility to Cut Banks’ Funding Costs by 200-250 bps

Source: Business Standard

Context:

The Reserve Bank of India’s (RBI’s) concessional swap facility for Overseas Foreign Currency Borrowings (OFCBs) is expected to provide banks with a cheaper source of funding at a time of sluggish domestic deposit growth. The facility is available to all Authorised Dealer Category-I banks, including private-sector lenders, for OFCBs with a minimum maturity of 3 years. The swap is at a fixed rate of 1.5 per cent per annum, compounded semi-annually, until 31 December 2026. Banks save 200-250 bps compared to market hedging costs of 3.5-4 per cent, with OFCB funds 40-50 bps cheaper than domestic deposits of similar maturity. SBI estimates banks may raise USD 5-8 billion through the OFCB route in FY27. Banks can raise up to 100 per cent of their Tier 1 capital through this window.

What is OFCB?

• Overseas Foreign Currency Borrowing (OFCB) is a broader category of foreign currency borrowings by Indian banks from overseas markets.
• A subset of OFCB is External Commercial Borrowings (ECBs).
• Foreign currency borrowing is the superset that includes:
  • ECBs (governed by RBI’s ECB framework).
  • Other foreign currency borrowings by banks.

What is ECB (External Commercial Borrowing)?

• A foreign currency loan raised by Indian residents from foreign lenders.
• Governed by the RBI’s Master Directions on ECBs.
• Two routes:
  • Automatic Route: For most sectors, no prior RBI approval needed.
  • Approval Route: For specific sectors and borrowers, prior RBI approval required.
• Recognised lenders: Foreign banks, foreign capital markets, multilateral institutions, etc.
• End-use restrictions: Cannot be used for on-lending to others, working capital, real estate (with some exceptions).

What is a Currency Swap?

• A financial derivative where two parties exchange currencies for a specified period and swap them back at a pre-agreed exchange rate.
• Used by banks and corporations to hedge currency risk on foreign currency exposures.
• Cost of swap: Depends on interest rate differentials, forward premium, and counterparty risk.

Authorised Dealer Category-I (AD-I) Banks

• A classification under FEMA, 1999 for banks that can deal in foreign exchange.
• AD-I can undertake all current and capital account transactions.
• AD-II can undertake limited transactions.
• Most scheduled commercial banks are AD-I banks.

What is Tier 1 Capital?

• The highest quality of capital that a bank holds, comprising:
  • Common Equity Tier 1 (CET-1): Equity capital, retained earnings, reserves.
  • Additional Tier 1 (AT-1): Perpetual debt instruments.
• Used as the primary measure of a bank’s financial strength under Basel III norms.
• A higher Tier 1 capital means better capacity to absorb losses.

About Certificates of Deposit (CDs) and Commercial Papers (CPs)

• Certificate of Deposit (CD): A short-term, negotiable money market instrument issued by banks to raise wholesale funds, typically with maturity of 7 days to 1 year.
• Commercial Paper (CP): A short-term, unsecured promissory note issued by corporates, primary dealers, and all-India financial institutions, typically with maturity of 7 days to 1 year.
• Both are wholesale funding instruments that banks and corporates use when retail deposits are insufficient.

Practice MCQs

Q1. With reference to the RBI’s OFCB Swap Facility, consider the following statements:

1. The swap rate is fixed at 1.5 per cent per annum, compounded semi-annually.
2. The window is open till 31 December 2026.
3. All Authorised Dealer Category-I (AD-I) banks, including private-sector lenders, are eligible.
4. The minimum maturity of OFCBs covered under the facility is 1 month.

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 minimum maturity is 3 years, NOT 1 month.)

Q2. With reference to the cost and benefit of the OFCB swap facility, consider the following statements:

1. The market hedging cost is about 3.5 to 4 per cent.
2. The RBI’s concessional swap rate of 1.5 per cent gives banks a saving of about 200-250 bps.
3. OFCB funds are estimated to be 40-50 bps cheaper than domestic deposits of similar maturity.
4. The facility allows banks to raise up to 100 per cent of their Tier 1 capital.

How many of the above statements are correct?

(a) Only one (b) Only two (c) Only three (d) All four (e) None

Q3. With reference to the Indian banking system context (May-June 2026), consider the following statements:

1. Credit growth was 17.7 per cent year-on-year by 31 May 2026.
2. Deposit growth was 12.2 per cent year-on-year by 31 May 2026.
3. The deposit-credit growth gap widened to about 550 bps.
4. India’s banking system has had no funding pressure recently, with deposits exceeding loan growth comfortably.

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; the banking system has been facing significant funding pressure, with credit growth outpacing deposit growth by about 550 bps.)

Q4. With reference to the broader RBI-government package for dollar inflows, consider the following statements:

1. The OFCB swap window aims to raise USD 5-8 billion in FY27, per SBI estimates.
2. The FCNR(B) special scheme has the RBI absorbing the hedging cost on fresh 3- to 5-year deposits.
3. The Fully Accessible Route (FAR) has been expanded to include new 15-, 30-, and 40-year G-secs.
4. The government has scrapped withholding tax and LTCG tax for foreign investors in G-secs.

How many of the above statements are correct?

(a) Only one (b) Only two (c) Only three (d) All four (e) None

Answer Key

1. (c), Statements 1, 2, 3 are correct; Statement 4 is wrong because the minimum maturity is 3 years.
2. (d), All four statements are correct.
3. (a), Statements 1, 2, 3 are correct; Statement 4 is wrong because the banking system has been facing funding pressure.
4. (d), All four statements are correct.

Exam Relevance

Banking (RBI Gr B, SBI PO, IBPS, NABARD)	Very high importance, OFCB, ECB, CD, CP, Tier 1 capital, AD-I banks
RBI Grade B	Core area on external sector and banking
SEBI Grade A and IRDAI Grade A	Capital markets and banking awareness