FCNR(B) deposits: Who bears the currency risk? | Explained
2-minute summary
In response to rupee depreciation pressures driven by high oil prices and a need to strengthen foreign-exchange reserves, the Reserve Bank of India (RBI) introduced a special foreign-exchange swap facility in June 2026. This encouraged Non-Resident Indians (NRIs) to park funds in Foreign Currency Non-Resident [FCNR(B)] deposits, enabling banks to mobilize over $127 billion—far exceeding the initial $50 billion target. The RBI closed this window on August 31, 2026. Under the arrangement, the RBI’s special swap facility shields banks from currency risk on the principal amount by bearing the hedging costs, which are offset by earnings from investing the foreign currency in higher-yield U.S. securities. However, banks must independently manage the foreign-exchange exposure and hedging costs for the dollar interest payments due upon maturity. While foreign banks mostly hedge this interest exposure, several state-run and private Indian lenders have left it unhedged to avoid a recurring annual hedging cost of about 3%, rendering them vulnerable to unexpected rupee depreciation.
Why it's in the news
The RBI recently closed its special swap window after Indian banks mobilized over $127 billion through FCNR(B) deposits, far surpassing initial targets. This massive dollar influx boosted the rupee, but exposed risks regarding unhedged dollar interest payments that domestic banks must manage.
Background and context
Foreign Currency Non-Resident [FCNR(B)] deposits are term deposits permitted to be maintained in specified foreign currencies by Non-Resident Indians (NRIs) and Persons of Indian Origin (PIOs). Introduced to attract stable foreign capital and bolster India's foreign exchange reserves during periods of external balance-of-payments stress or rupee volatility, these deposits allow account holders to earn interest in foreign currency without bearing exchange rate risks on principal repatriation. The RBI periodically utilizes special foreign-exchange swap windows—where banks swap foreign currency inflows with the RBI for rupees while the RBI manages the forward exchange risk—to inject liquidity, ease pressure on domestic financial conditions, and fortify forex buffers.
Previous UPSC questions on this theme
- Prelims GS-1 2021 — Consider the following : 1. Foreign currency convertible bonds 2. Foreign institutional investment with certain conditions 3. Global depository receipts 4. Non-resident external deposits Which of the above can be included in Foreign Direct Investments? (a) 1, 2 and 3 (b) 3 only (c) 2 and 4 (d) 1 and 4
Mains practice: Examine the role of non-resident deposit schemes like FCNR(B) in managing India's foreign exchange reserves and stabilizing the rupee. What are the systemic risks involved for domestic banking institutions?
Introduction:
Foreign Currency Non-Resident [FCNR(B)] deposits serve as a vital financial instrument for India to attract stable foreign capital, bolster foreign exchange reserves, and defend the rupee against external shocks such as high global oil prices or capital outflows.
Body:
• Role in Reserves and Stability: Schemes like FCNR(B)—backed by special RBI swap windows—allow banks to rapidly mobilize billions in foreign currency, strengthening forex buffers and providing temporary relief to a weakening domestic currency by increasing dollar liquidity.
• Risk-Sharing Architecture: Under RBI swap arrangements, the central bank shields commercial banks from currency risk on the principal amount, offsetting its hedging costs through high-yield investments in U.S. securities.
• Systemic Vulnerabilities for Banks: While principal is protected, banks are typically responsible for managing dollar interest payments independently. Many state-run and private lenders leave this interest exposure unhedged to avoid high annual hedging costs (approx. 3%).
• Macroeconomic Implication: If the rupee depreciates significantly over the 3-to-5-year deposit tenure, unhedged banks face sharply escalated rupee-denominated liabilities when paying out interest, posing potential profitability and balance-sheet risks.
Conclusion:
While non-resident deposit mobilizations effectively reinforce India's external macro-stability buffers, regulatory oversight must ensure that commercial lenders prudently manage residual foreign exchange exposures to prevent localized banking vulnerabilities from transforming into systemic risks.
Prelims practice questions
Q1. With reference to Foreign Currency Non-Resident [FCNR(B)] deposits in India, consider the following statements: 1. These deposits can be maintained in specified foreign currencies by Non-Resident Indians (NRIs). 2. Under a typical RBI special swap facility for FCNR(B) deposits, the central bank shields banks from foreign-exchange risk on the principal amount. 3. The interest earned on FCNR(B) deposits is paid out in Indian Rupees (INR) at prevailing spot rates.
- 1 and 2 only
- 2 and 3 only
- 1 and 3 only
- 1, 2 and 3
Answer: A. Statement 1 is correct: FCNR(B) deposits are held in designated foreign currencies by NRIs/PIOs. Statement 2 is correct: The RBI's special swap facility shields banks from currency risk on the principal amount. Statement 3 is incorrect: FCNR(B) deposits and their interest payments are maintained and paid out in foreign currency, not converted automatically to INR for interest disbursement.
Q2. What is the primary objective of the Reserve Bank of India (RBI) implementing a special foreign-exchange swap facility for FCNR(B) deposits?
- To provide long-term infrastructural loans to domestic manufacturing companies
- To encourage capital outflows and reduce domestic liquidity
- To incentivize NRIs to channel funds into deposits, thereby bolstering foreign-exchange reserves and stabilizing the rupee
- To directly regulate interest rates charged by foreign commercial banks operating in India
Answer: C. The RBI introduces special swap facilities and encourages FCNR(B) mobilization to attract foreign currency inflows from NRIs, which adds to India's foreign-exchange reserves and helps stabilize the rupee under depreciation pressure.
Q3. In the context of FCNR(B) deposit schemes, what does 'currency risk on interest payments' primarily imply for unhedged domestic banks?
- Risk of default by the central bank on its sovereign bonds
- Risk of international rating agencies downgrading the bank due to excess foreign reserves
- Risk of mandatory conversion of foreign currency deposits into domestic equity shares
- Risk that a weakening rupee will increase the rupee cost required to procure dollars for interest payouts at maturity
Answer: D. If banks leave their dollar interest liability unhedged, a depreciation of the rupee means they will need more rupees to purchase the required dollars when interest is paid out at maturity, directly impacting their financial health.
Revision flashcards
- What are FCNR(B) deposits? Foreign Currency Non-Resident (Bank) deposits are term deposits held in specified foreign currencies by NRIs and PIOs with banks in India.
- Who bears the currency risk on the principal of FCNR(B) deposits under the RBI's special swap facility? The Reserve Bank of India (RBI) bears the foreign-exchange risk on the principal amount through its swap arrangement.
- Who bears the currency risk on the interest payments of FCNR(B) deposits? The commercial banks themselves must manage and bear the foreign-exchange exposure for dollar interest payments.
- Why do some Indian banks leave their interest exposure unhedged? To avoid the high recurring cost of hedging (approximately 3% annually) over the 3-to-5-year deposit tenure.
- How does the RBI offset the cost of hedging the principal under the FCNR(B) swap facility? By investing the mobilized foreign currency reserves into higher-yield U.S. securities (earning roughly 4.5–5%).