FCNR(B) deposits cross $127 bn: Why margin worries may be overdone

According to fresh market updates, Banks have received $127.3 billion in FCNR(B) deposits since June, marking a firm response to the RBI’s scheme and taking total inflows to $136.4 billion. While the street is concerned that the elevated cost of these deposits could put pressure on banks’ margins, Anand Rathi market watchers say the impact is likely to be limited, with the ability to lend more of the funds and use less capital potentially improving banks’ overall returns.

Margin impact likely to be negligible

The FCNR(B) scheme, rolled out on June 8 with the RBI bearing the cost of forex hedging, has noted a firm response from banks. FCNR(B) deposits alone have brought in $127.3 billion, while inflows including OFCBs and ECBs have touched $136.4 billion.

According to Anand Rathi, FCNR(B) deposits now account for around 4.5% of the banking system’s total deposits.

The firm inflows have additionally led to concerns that the elevated cost of FCNR(B) funding could weigh on banks’ net interest margins (NIMs). That stated, Anand Rathi believes the concern is overstated.

The brokerage analysed four scenarios and found that the impact on NIMs is negligible. This is because the elevated cost of FCNR(B) funding applies only to a small portion of banks’ overall deposit base, meaning its impact on the overall cost of deposits stays limited.

Why returns could still improve

Anand Rathi says the bigger benefit for banks comes from how these deposits can be used.

FCNR(B) deposits are exempt from CRR, SLR and PSL requirements. This means banks can deploy a larger portion of the money into loans instead of keeping part of it aside to meet regulatory requirements.

In simple terms, banks can use more of the money they raise to generate income.

The brokerage additionally points out that banks can lend against FCNR(B) deposits pledged by customers. Since these loans are backed by the deposits, they require very little additional capital.

This means banks can earn a spread on these loans while using relatively little capital, which can improve their return on equity (RoE), even if there is a small impact on NIMs.

Elevated rates could further help

The three-to-five-year tenure of FCNR(B) deposits could additionally benefit banks if interest rates stay high.

The cost of these deposits stays set for the tenure, while many bank loans are floating-rate and can be repriced when interest rates climb. This could allow banks to earn a wider spread over time.

That stated, Anand Rathi cautions that the benefit could reverse if interest rates enter a sustained cutting cycle.