Foreign banks will provide upfront financing for wealthy non-resident Indian clients to entice them to place bulky dollar deposits back home in response to India's drive for dollar funding to defend its weak currency, sources said.
This would resurrect a practice which proved successful in drawing in dollars from non-resident Indians (NRIs) in 2000, when the rupee was also under pressure, and the sources said banks could raise about $10 billion or more.
Foreign banks will finance the bulk of these dollar deposits. This is likely to be welcome news for Indian authorities because it could avoid the need for a sovereign bond or special government-backed deposit schemes to attract dollar inflows to support the rupee.
Banks including Citi, DBS and Standard Chartered Bank are offering the terms to the richest segment of their private banking clients by providing roughly 90 per cent of the foreign currency deposit placed in India, four private banking sources said.
The banks will officially roll out the upfront loans this week, the sources said.
"Client equity in these deposits is just 10 percent and the client effectively makes between 18 and 21 per cent on the dollars," said a private banker with a European bank.
The scheme is a variation of the foreign currency non-resident bank account (FCNR), which are term deposits non-resident Indians can maintain in five currencies, including U.S. dollars, euros and pounds, at banks onshore and earn a fixed rate of interest.
As part of efforts to rescue the rupee as it sank towards record lows near 69-per dollar in late August, the Reserve Bank of India (RBI) freed interest rates on FCNR deposits last month.
It allowed banks to offer as much as 400 basis points over the London interbank offered rate (LIBOR) for deposits with maturities between 3 years and 5 years. It exempted these deposits from statutory bank reserves.
To incentivise banks, the RBI also offered to swap FCNR deposits of maturities above 3 years into rupees at a fixed rate of 3.5 per cent, less than half the prevailing market levels. That swap window is available until November 30.
Investors need to have just 10 percent of the amount of deposit they intend to place, and can earn nearly 20 percent on their dollars.
Foreign banks can earn 3-4 percentage points over Libor for their dollars, while local banks in India can swap those dollars into rupees more cheaply than market rates using the central bank swap window.
Banks, both foreign banks with presence in India and local ones, have made a huge push to raise money from India's vast diaspora since the RBI relaxed rules on FCNR deposits. The FCNR deposits can be used as collateral to borrow overseas.
The difference in the new upfront financing scheme is that the banks pool their resources with non-residents and place deposits in India, thus creating bigger deposits with each new account.
One source at a European bank said that the effective cost of rupee funds would be about 8.5 to 9 per cent. Ten-year rupee government bonds yield 8.5 per cent.
Secondly, there were unresolved issues of how much credit exposure foreign banks wanted to take on their India branches, and who would place the collateral for the loans and take the risk of premature withdrawal of the deposit by the non-resident Indian.