FCNR(B) deposits: Who bears the currency risk? | Explained

Published 2026-09-11 · Updated 2026-09-11 · 4 min · 663 words

UPSC CSE Context

Why in News

RBI's special swap facility for FCNR(B) deposits has raised questions about who bears currency risk on principal and interest payments.

Syllabus Connection

Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment; Effects of liberalization on the economy.

Exam Relevance

Understanding currency risk management and RBI's role in external sector stability is crucial for UPSC CSE Mains GS Paper 3 and Prelims.

Core Issue

RBI swap covers principal currency risk; banks bear interest payment risk.

Key Development

Banks mobilized over $127 billion via FCNR(B) deposits, far exceeding RBI's $50 billion target, but many left interest exposure unhedged.

Stakeholders

• Reserve Bank of India
• Indian banks (state-run and private)
• Non-resident Indians
• Foreign banks

Static Knowledge

High-Value Background

• FCNR(B) deposits are foreign currency non-resident bank deposits that allow NRIs to hold deposits in foreign currency, protecting them from exchange rate fluctuations.
• RBI's swap facility is a tool to attract foreign currency inflows and bolster forex reserves during times of rupee pressure.

Exam Linkage

• Relevant for questions on external sector management, capital account convertibility, and RBI's monetary policy tools.

Concepts in Context

• Currency risk arises when assets or liabilities are denominated in foreign currency and exchange rates fluctuate.
• Hedging is a strategy to offset potential losses from currency movements using financial instruments.

Institutions and Mechanisms

• RBI manages India's foreign exchange reserves and intervenes in forex markets to maintain stability.

Dynamic Analysis

Economy

• The swap facility effectively transfers principal currency risk from banks to RBI, reducing banks' incentive to hedge interest payments.
• Unhedged interest exposure could lead to simultaneous dollar purchases at maturity, increasing demand for dollars and pressuring the rupee.
• RBI's potential earnings from investing reserves in higher-yield US securities may offset hedging costs, but this depends on global interest rate differentials.
• The scheme's success in attracting deposits may encourage similar measures in future, but it also creates contingent liabilities for RBI.

Governance

• RBI's decision to close the window early indicates a need to manage excessive inflows and prevent overheating of the forex market.
• The lack of mandatory hedging requirements for banks exposes the financial system to aggregate currency risk, raising regulatory concerns.
• State-run banks' reluctance to hedge may reflect governance issues or risk management gaps, requiring supervisory oversight.

International Relations

• The scheme's success reflects strong NRI confidence in India's economic stability, but it also increases India's external liabilities.
• Large forex reserves provide a buffer against external shocks, but unhedged bank exposures could undermine this buffer if the rupee depreciates sharply.

Mains Value Addition

Arguments

• Unhedged currency exposure in the banking sector can amplify systemic risk during periods of rupee depreciation.
• The scheme's cost to RBI is manageable given India's large forex reserves, but it reduces RBI's net foreign assets and may limit future intervention capacity.

Examples

• If a bank has to pay $1 million interest and the rupee weakens from ₹95 to ₹100 per dollar, the cost rises from ₹9.5 crore to ₹10 crore.

Data Points

• RBI recouped $31.2 billion of foreign currency assets by August 7, 2026, equivalent to 55% of mobilized amount.
• Hedging cost estimated at up to 3% per year; RBI could earn 4.5-5% on reserves.

Counterpoints

• Some banks argue hedging is too costly and prefer to buy dollars at maturity, accepting the risk.
• If the rupee remains stable or appreciates, unhedged banks may benefit from lower costs.
• RBI's earnings from reserves may not fully offset hedging costs if global yields decline.

Way Forward

• RBI should consider mandating partial hedging of interest exposure for banks participating in such schemes to mitigate systemic risk.
• Banks should strengthen internal risk management frameworks to assess and manage currency risk on foreign currency liabilities.
• RBI could provide forward guidance or develop a market for long-term currency swaps to reduce hedging costs.
• Regulators should monitor aggregate unhedged exposures and set prudential limits to prevent excessive risk accumulation.
• Enhance transparency by requiring banks to disclose their currency risk management strategies in financial statements.

Primary/reference source: Economy