FCNR(B) – What does this domino effect mean for banks

(Continuing from yesterday…see here)

The implications of a successful FCNR(B) campaign for the banking sector are far-reaching.

First, and most directly, FCNR(B) deposits will not attract CRR or SLR requirements on the incremental amounts. This is not a new concession — the same dispensation applied in 2013 — but it means that every dollar raised through this route translates almost entirely into deployable liquidity. A $40 billion inflow, at a spot rate of approximately Rs 93-95 per dollar, would inject Rs 3.7-3.8 lakh crore into the system. This is a very large number. For context, the entire banking system’s liquidity deficit through most of early 2025 was in the range of Rs 1.5-2 lakh crore.

Second, the scheme addresses the CD ratio problem in a way that domestic deposit mobilization efforts cannot quickly replicate. NRI deposits are not cannibalizing domestic savings — they represent an external infusion. Banks that succeed in raising substantial FCNR(B) deposits could see their CD ratios ease meaningfully, reducing the pressure to offer higher domestic deposit rates and thereby protecting net interest margins.

Third, as one analyst report aptly noted, successful mobilization “should have a sobering effect on loan pricing and other market-based yields across commercial papers, certificates of deposit, and government securities, helping in true transmission.” Put simply, additional liquidity should reduce the cost of credit across the economy — something that rate cuts alone have struggled to deliver in a tight liquidity environment.

Fourth, the scheme provides a measure of protection against wholesale deposit instability. When a bank can replace jumpy institutional deposits with longer-tenor (three to five year) NRI money, the structural fragility of its liability side reduces meaningfully.

The BoP dimension: Managing the external account

The FCNR(B) scheme is as much an external account management tool as it is a banking sector liquidity measure. India’s balance of payments position is at risk of marked deterioration. The current account deficit could widen on account of sustained elevated crude oil prices and widening trade deficit with major partners. Simultaneously, Foreign Portfolio Investment (FPI) flows into Indian equities turned volatile and net negative through significant portions of FY26, as global investors rotated away to developed markets and other emerging markets.

The rupee, consequently, bore the brunt. Having crossed 90 against the dollar in early 2026 and continuing to slide toward 94-95 in subsequent months, the currency’s weakness threatened to become self-reinforcing through imported inflation, higher oil import bills, and corporate balance sheet pressures for those with unhedged foreign currency liabilities.

The RBI has been intervening, but at a cost. Since February 2026 alone, over $38 billion of foreign exchange reserves were deployed to cushion rupee depreciation — drawing down reserves from their peak of $728.49 billion. At $681-682 billion, reserves remain substantial (covering approximately 11 months of merchandise imports, per the RBI Governor), but the rate of attrition is a concern.

The FCNR(B) inflows would replenish that buffer without requiring the RBI to buy USD in the open market. In effect, the scheme converts long-term NRI savings into a direct reserve-building exercise — a far more durable source of forex inflows than short-term portfolio capital. In 2013, the $34 billion raised through FCNR(B) was widely credited with stabilizing the rupee and turning the BoP position around. The hope is for a similar impact, though the quantum and speed of inflows will determine the ultimate efficacy.

The 2013 Comparison: What is different this time

The 2013 FCNR(B) episode under Raghuram Rajan is rightly remembered as a masterclass in crisis management. Within weeks of the announcement, market sentiment turned, the rupee stabilized, and $34 billion flowed in — far exceeding initial expectations. But 2026 is not 2013, and a few important differences merit attention.

In 2013, the episode was triggered by a single, identifiable shock — the Fed’s taper tantrum. Once the global environment stabilized and the RBI acted decisively, confidence returned quickly. The current challenge is more diffuse: a mix of geopolitical risks (the West Asia war and its oil price consequences), US tariff uncertainty, structural domestic demand softness, and a banking system that is adjusting from a period of unusually high credit growth. There is no single event to “catch.”

Additionally, while NRI depositors have always been rate-sensitive, the global interest rate environment today offers them competitive alternatives that did not exist in 2013 in the same way. US Treasury yields, for instance, remain elevated. The deposit and lending rates in countries like the US, the UAE, and Singapore are also much higher as compared to 2013. The spread offered by FCNR(B) deposits may not be compelling enough to overcome home country inertia and alternative opportunity costs.

Finally, the RBI’s hedging cost today — borne at approximately 2.9% per annum — represents a meaningful cost to the central bank’s balance sheet and, by extension, to its future surplus transfers to the government. If $40-50 billion is raised, the annual hedging cost borne by the RBI could be in the range of $1.2-1.4bn. That is not a prohibitive number given the BoP stability it purchases, but it is not insignificant either, if we consider that the annual budget of ISRO is US$1.4bn.

Another point to be noted is that in 2013 most of the incremental FCNR deposits were used to augment the reserves. Besides, other measures, e.g., reduced LSR remittance limits, were also used to limit the outflows. This time, much of the incremental deposits could just end up replenishing the FII and Net FDI outflows.

Investment Implications: What Should the Analyst Track?

For investors in Indian banking stocks, the emerging picture suggests a period of transition rather than resolution. Several themes are worth tracking.

On the positive side, if FCNR(B) inflows are substantial — say in excess of $30bn — the banking sector will be a meaningful beneficiary. System liquidity improvement will reduce reliance on expensive wholesale deposits, compress deposit costs, and allow for better NIM protection. Banks with stronger NRI relationships and international banking capabilities — notably the larger private sector banks and SBI, which has an extensive overseas network — may be better positioned to capture these flows.

The rupee stabilization effect, if it materializes, will reduce the import cost burden for the economy broadly and ease inflationary pressures, which would in turn support the RBI’s ability to maintain accommodative monetary conditions.

On the risk side, investors should remain cognizant that the FCNR(B) scheme creates a large matured liability for banks for three to five years hence. When these deposits mature — between 2029 and 2031 — the banks must return the foreign currency. If India’s external account is under stress at that point, the rollover risk could be significant. This is precisely what happened when the 2013 FCNR(B) deposits matured in 2016: the RBI had to manage a significant outflow, though it did so without incident. The lesson is that today’s relief is tomorrow’s contingent liability.

The fiscal trajectory remains a key watch item. A government that continues to miss its tax revenue targets while facing disinvestment underperformance will compete with the private sector for available savings — keeping yields higher than they otherwise would be and limiting the NIM upside from liquidity improvement. Resolution of the fiscal challenge is a necessary condition for a durable easing of banking sector stress, not a sufficient one in isolation.

FCNR(B) inflows – the likely scenario

Most large banks have announced rates for 3-year FCNR(B) deposits in excess of US$1mn in the range of 6-6.15%. Some smaller banks have even offered 7%.

The actual inflows would largely depend on the domestic credit franchise (how much of the mobilized USD it can lend/sell under LRS to the domestic borrowers) of the mobilizing banks.

The actual deal is the NRI depositor borrows from the overseas banks and deposits as FCNR(B) with an Indian branch.

The rate of lending to the depositors would depend on one-month SOFR and 3-year interest rate swap, expected credit cost provision and profit margin for the bank. Considering a 19x leverage (5% margin), the net return to the depositor could be in the range of 13-15% p.a. on the principal amount invested.

Conclusion

RBI, facing a multi-dimensional challenge — banking liquidity, currency weakness, BoP stress — has done well to use a time-tested measure. The FCNR(B) scheme could addresses all three simultaneously, while supplementing it with USD/INR swaps that ease domestic liquidity without burning down reserves. This is not panicked firefighting; it is deliberate central banking.

The banking sector will benefit, but investors should resist the temptation to extrapolate from 2013. The structural challenges that created the problem — a financializing household saving base that increasingly prefers non-bank instruments, a fiscal deficit that crowds and constrains, a growth model that generates more credit demand than the deposit base can organically support — will not dissolve with a single scheme, however well-designed.

The CD ratio will ease. The wholesale deposit overhang will moderate. Liquidity conditions will improve. But the medium-term question — how India’s banking system funds a $5 trillion economy when households are increasingly choosing the mutual fund and corporate debt over the fixed deposit — remains open. That is the question the banking sector and its regulators will have to answer over the coming decade, one policy measure at a time.

Also Read

How the Indian financial sector is navigating a perfect storm