Dubai: Thousands of non-resident Indians (NRIs) who invested their hard-earned money in leveraged Indian rupee deposit products offered by some of UAE-based banks stand to lose heavily from the recent decline in rupee value.
The Indian rupee slumped to 71 a dollar on Friday, an all-time low. The embattled currency has lost about 10 per cent this year. Going by simple logic, NRIs should be a happy bunch who can now fetch a better exchange rate for their dirhams.
Leveraged gamble: what did these investors do?
Unfortunately, there are a different set of NRIs who stand to pay a heavy price as the Indian currency continued to tumble against the dollar. These are mostly investors who bought leveraged NRE [non-resident external] deposit products offered by a number of banks in the UAE, in association with some of the leading Indian banks.
A number of banks in the UAE have been offering investors the opportunity to invest in NRE deposits, to make a decent return on interest rate differences in India and the UAE. Most banks offer products with a minimum investment contribution of $150,000 (Dh550,875) from their clients. On these, banks offer up to six times leverage.
For all practical purposes, leverage is a loan that comes with an interest rate.
The money so borrowed [for example in the case of five times leverage on $150,000 creates a total investable amount of $900,000] is then remitted to India at the prevailing exchange rate to a tax-free NRE account, that earns up to 8.5 per cent depending on rates offered by Indian banks.
While the banks charge about 1 to 1.5 per cent fee on the total amount remitted to India and an interest rate of about 2.5 per cent on the leveraged funds. In addition, customers will also pay for the currency hedge against future fall in the rupee.
Source of trouble: what is going wrong?
The product works well for clients and banks, as long as the underlying (rupee) remains strong against the dollar.
But as the currency depreciates, the total value of investment also declines directly, impacting the share of investor’s equity. When the rupee breaches the level (of exchange rate at which it is hedged, the investor bears the losses on the entire investment (client contribution + leverage).
As per the structure of these products, the amount is deducted from the investor’s contribution. In addition, once the primary hedge near its expiry, clients are advised to re-hedge their positions taking a view to what extent they want protection. Investors say banks that sold these products are doing nothing to help them.
“Following the recent rupee depreciation, banks have contacted us informing we have two options: 1) re-hedge our position by purchasing additional insurance which is very expensive, depending on up to what rate of exchange level we would like to protect our investments, or 2) do nothing, let our current insurance expire once the rupee breaches the insured level, and bear the full brunt of the exchange loss on maturity of the NRE fixed deposit at the prevailing rate of exchange on maturity,” said a customer who has exposure close to Dh10 million.
Information filtering in from investors and banking industry sources suggests there are several thousands NRI investors who have exposure to these products. Going by the recent fall in the rupee, analysts say some of these investors could lose as much as 70 to 80 per cent of their equity depending on the level at which the currency is hedged and the level of exchange rate at the maturity of these deposits.
Margin calls: banks protected, clients at risk
The structure of this product is such that the risk is entirely on the client and the bank is fully protected. In all of these product offerings, banks mark a lien on the NRE fixed deposit as collateral to their dollar loan (the leverage component) to secure themselves. Therefore, as the rupee falls, the value of this rupee collateral in dollar terms also falls. The banks then trigger a ‘margin call’ towards investors to inject more capital that would be blocked by the bank, as additional collateral to safe guard the bank’s loan.
Investors must have liquidity to fund these margin calls — if not, the bank reserves the right to unwind the entire structure by pre-maturely breaking the NRE deposit.
As Indian banks do not pay any accrued interest if an NRE deposit is prematurely broken, this loss of interest further increases the client loss. In addition, remitting the funds back to the UAE in US dollars at the prevailing exchange rate forces the clients to book 70-90 per cent loss on their equity. The bank takes back the value of its loan plus the accrued interest till date in dollars, from the repatriation proceeds. The frequency and amount of margin calls go up as the rupee depreciates.
Banks, on the other hand, said investors had been made aware of the risks of currency depreciation and were advised to take hedges against exchange rate losses.