RBI’s attempt to dump excess dollars offers lucrative trade for banks

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The biggest beneficiaries have been foreign banks, which have easy access to large stocks of dollars

The Reserve Bank of India’s attempt to flush out surplus US dollars from domestic markets has provided a unique arbitrage opportunity for some banks. Lenders are using a regulatory loophole to profit from transactions in currency futures markets, according to people with knowledge of the matter. A large bank could easily rack up exposures of more than $ 1 billion, several traders said, asking not to be identified as transactions are not public.

The strategy revolves around a regulatory change in February that lowered local banks’ exposure limits to other sovereign assets, such as US Treasuries, allowing them to take advantage of a spread in the dollar rupee markets. Extensive intervention by the RBI had driven 12-month implied returns for the currency pair to their highest for more than four years.

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The biggest beneficiaries have been the country’s foreign banks, which have easy access to large stocks of dollars, the people said. As the largest buyer of the greenback in the futures market, the RBI effectively funds a portion of trading profits.

Here is how it works. Banks would convert rupee deposits into dollars using a buy-sell swap – buying the greenback now while selling the same amount on a specific date in the future. They use the proceeds to buy treasury bills, under the newly relaxed RBI rule. The return is in the arbitrage: they pay around 3.5% on local currency deposits, while earning 4.9% on one-year term premiums.

During the talks, the central bank made it clear that lenders should deploy dollars from their own stock and not use swaps to make investments under the newly relaxed rules, people said. However, the written rules fail to define what constitutes bank resources to use for investments – creating a loophole for lenders to get more greenbacks through swaps.

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Since there are no longer limits on the amount that these banks can invest abroad, there is – at least from a regulatory point of view – no cap on the exposures they can have.

Relaxed rules

The trades are not illegal and there is no suggestion of wrongdoing. An email to an RBI spokesperson on Tuesday afternoon went unanswered.

When RBI Governor Shaktikanta Das changed the rule on banks’ exposure to foreign assets two months ago, this was expected to lead lenders to use their excess dollars to buy bonds. of the Treasury, rather than flooding the local market with the greenback.

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If the banks have done so, they are profiting from the currency markets. To be sure, the February rule change and these transactions helped lower 12-month term premiums to 4.9% from 5.4%, reducing hedging costs for businesses.

The RBI had absorbed capital inflows – driven by a dynamic stock market and acquisitions – to such an extent that its foreign exchange reserves became the fourth largest in the world. The intervention in the spot market and sterilized in forwards led to a surge in the 12-month rate.

As a result, the central bank’s long dollar pounds jumped to $ 47.4 billion at the end of January, from $ 4.9 billion in March 2020.

(Except for the title, this story was not edited by The Bharat Express News staff and is posted Platforms.)

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