Banks have raised over $32 billion through FCNR(B) deposits, but experts warn that lending against these funds could create liquidity and asset-liability mismatches. As global interest rates fluctuate, banks must manage potential premature withdrawals and loan interest servicing risks to protect their profit margins.
Indian banks have successfully mobilized more than $32 billion under the special Foreign Currency Non-Resident (B) or FCNR(B) deposit scheme. This program, which provides a zero-cost swap facility for deposits with tenors ranging from three to five years, was designed to strengthen India's foreign exchange reserves and support the rupee during challenging global economic conditions.
While the influx of foreign currency is a positive for the banking sector's liquidity position, the practice of offering loans against these deposits has introduced new challenges. Financial experts are highlighting that as high-net-worth non-resident investors participate, banks face a growing concentration risk. If these investors decide to withdraw their funds after the initial one-year lock-in period, especially in response to shifts in US Federal Reserve interest rates, banks could face sudden liquidity pressure.
Asset-Liability and Interest Risks
Beyond basic liquidity, the banking sector faces complications in balancing their books, known as Asset Liability Mismatch or ALM. Since these deposits are committed for three to five years, but loans may be utilized differently, the timing of cash inflows and outflows may not align. This creates a risk if the bank is forced to scramble for funds in a volatile market to cover unexpected withdrawals.
Furthermore, while banks are technically secured because they hold a lien on the deposits—meaning they can seize the deposit if the borrower defaults on the principal—the risk lies in interest payments. The security does not automatically cover the regular servicing of interest on the loans. If global economic conditions worsen, the ability of borrowers to keep up with these interest payments could decline, putting pressure on bank earnings.
Impact on Profit Margins
Banks are now tasked with the difficult job of pricing these loans to account for these hidden risks. If they price loans too low, they risk hurting their Net Interest Income, which is the difference between what a bank earns on loans and what it pays on deposits. To offset this, banks might be tempted to adjust domestic deposit rates, but this could alienate domestic retail customers.
Investors should track how individual banks manage their loan-to-deposit ratios and whether they provide specific disclosures on the quality of their FCNR(B)-linked loan portfolios. The Reserve Bank of India’s oversight remains the primary guardrail for the sector, but the internal management of these assets will be a key factor for bank profitability in the coming quarters.