Apropos the report "Foreign banks to give upfront loans for Indian dollar deposits" (September 17), it appears that there is a positive endorsement to increased foreign currency flows on account of leveraged deposits.
The process involves a non-resident Indian (NRI) depositor making a foreign currency non-resident (FCNR) deposit in India through an overseas branch of an Indian bank (or a foreign bank with operations in India), then borrowing locally (at the overseas centre) against the same deposit with a haircut of, say, 5 per cent, at rates linked to the London Interbank Offered Rate (Libor), and redepositing the borrowed amount in another FCNR deposit with the same bank. This process can be repeated any number of times till no more borrowings are possible against the last deposit - normally it is limited to 8 to 10 times. This implies that an NRI with an initial FCNR deposit of $10 million, can create an aggregate FCNR deposit of $80 million with a leverage of 10 times (the 21 times appearing in the news item is less common).
The advantage to the depositor is that the Libor-linked interest (generally at around L+0.5 per cent, since it is fully secured by deposit) is far less than the dollar interest paid on FCNR deposits by Indian banks - currently at around 4.95 per cent. The regulatory arbitrage works out to a minimum 4 per cent per deposit, and the aggregate earnings of the NRI on the initial deposit would easily work out to more than 30 per cent per annum.
The upfront funding is only a ruse and the scheme is not confined to "wealthy" clients as stated in the report. An NRI with $10,000 can walk in to any Indian bank's overseas branch and multiply his income. Foreign banks, of course, target larger deposits and are less reluctant to provide higher leverage.
This is a racket loathed by central banks in all developed markets and I hope the Reserve Bank of India will also prohibit banks explicitly from creating such fictitious deposits. Apart from ethical questions, there is no way the bank can earn 4 per cent on the dollar deposits in India - together with hedging costs when they lend the funds back in rupees, unless they raise rupee lending rates at the cost of the domestic borrower.
C Chandrasekhar, Mumbai
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