RBI Bears Principal Risk in FCNR Deposits

Indian banks raised $127 billion through FCNR(B) deposits. This figure exceeds the initial $50 billion target set by the Reserve Bank of India. The RBI closed the window for new deposits on August 31, 2026. The scheme provided cheap foreign-currency funding for banks. It also added to India's foreign-exchange reserves.

The RBI introduced a special swap facility in June. This facility shields banks from currency risk on the principal amount. Banks must manage the risk on interest payments themselves. The distinction defines the financial exposure for each party. The deposits typically have maturities of three to five years.

RBI Hedging Costs and Returns

The RBI bears the cost of hedging the principal. BofA Securities estimates this cost at up to 3%. SBI Research uses a similar 3% annual average. The RBI recouped $31.2 billion of foreign-currency assets by August 7, 2026. This amount represents 55% of the mobilized funds at that time.

BofA estimates the RBI could earn 4.5% to 5% on these reserves. This yield can offset the hedging cost. SBI Research calculates an annual notional cost of $2.1 billion. Over five years, the cumulative cost reaches $10.5 billion. This equals 1.45% of India's $700 billion reserve stock.

Bank Exposure on Interest Payments

Banks remain exposed to currency risk on interest. They must arrange dollars for these payments. Foreign banks largely hedge this exposure. Most state-run banks leave it unhedged. Several private-sector Indian lenders also avoid hedging. The primary reason is the high cost of protection.

Hedging interest risk costs approximately 3% per year. Interest is paid at deposit maturity. Some banks plan to buy dollars in the spot market. They will make these purchases only when payments are due. This strategy avoids upfront hedging costs. It exposes the bank to future exchange rate fluctuations.

Impact of Rupee Weakness

A weakening rupee increases the cost of interest payments. Consider a bank owing $1 million in interest. If the dollar costs 95 rupees, the payment is 9.5 crore rupees. If the dollar rises to 100 rupees, the cost becomes 10 crore rupees. Hedged banks lock in the rate. Unhedged banks pay the higher spot rate.

GN markets/fx (en-US) notes the divergent strategies among lenders. State-owned entities face higher potential losses if the currency depreciates. Private banks show mixed approaches. The total system risk depends on the final exchange rate. The RBI's reserve gains provide a buffer. Bank balance sheets carry the residual risk.