New Delhi: Foreign banks have been forced to unwind billions of dollars worth of profitable currency trades at the behest of India’s central bank.
The issue in focus is a flurry of currency swap trades that involved the banks converting rupee-denominated deposits into dollars that were then used to buy foreign sovereign debt including US Treasuries, which are unlisted in India. The Reserve Bank of India (RBI) warned the banks of a regulatory breach last week, saying they must limit their holdings of such unlisted securities to no more than 10 per cent of investments classified as the non-statutory liquidity ratio portfolio.
Some lenders had racked up exposures of more than $1 billion each by using a regulatory loophole created in February to convert rupee deposits into dollars using a buy-sell swap - buying the greenback now while selling the same amount at a specified date in the future. They then used the proceeds to purchase US government debt and profited from the arbitrage, paying around 3.5 per cent on the local currency deposits.
earnings on 12-month yield on the currency pair
RBI to fund banks’ profits
As the biggest buyer of the greenback in the forwards market, the RBI was effectively funding some of the trading profits.
The central bank, as part of its intervention strategy, had been offsetting its dollar purchases in the spot market, by entering into sell-buy swaps in the forwards markets. That had swelled its forwards book to over long $70 billion, causing dollar/rupee forward premiums to spike and foreign banks to book arbitrage gains from the trade earlier this year.
Indian entities were net buyers of almost $3 billion worth of Treasuries over April and May, according to US government data, the first inflows from the South Asian nation since October. The biggest beneficiaries of the swap trades have been overseas lenders in India, which have easy access to large dollar investments, the people said. An email to the RBI was unanswered.
The banks are in the process of unwinding the trade, the people said. They are selling Treasuries and conducting sell-buy swaps - selling the greenback and agreeing to buy at a later date specified in the contract.