Mumbai: The Reserve Bank of India (RBI) on Friday said it will lend foreign exchange to banks with overseas operations to meet their lending requirements, a move that Indian banks have been asking for, and which could ensure adequate funding for their foreign subsidiaries.
Mint had reported on 22 October that banks had asked for at least $10 billion (Rs47,800 crore today) in such credit and that this was also a key recommendation of the October report of the liquidity panel trust set up by the finance ministry and headed by finance secretary Arun Ramanathan.
The lending will be done through foreign exchange swaps of up to three months using interest rates in the domestic and the overseas markets and the RBI reference rate for the dollar-rupee exchange rate, the country’s banking regulator said in a statement.
A currency swap is an agreement between two parties to exchange two currencies on a future date at a specific price. RBI’s latest move will infuse dollars directly into the banks and help strengthen the local currency.
Following the central bank’s announcement, banks will buy dollars from RBI at the reference rate plus three-month forward premium and will return dollars to RBI after three months, in case of a swap of three months. As on Friday, RBI’s dollar rupee reference rate was Rs47.76 per dollar. In the forwards market, the three-month forward premium was 57 paise.
Additionally, the central bank has also extended a lifeline to banks for funding the swaps by allowing them to borrow through its regular liquidity adjustment facility (LAF), or the window through which it lends to or accepts money from banks, for the corresponding period at the prevailing policy rate. The current policy rate stands at 7.5% after a 100 basis point cut announced last Saturday. One basis point is one-hundredth of a percentage point.
Banks borrow through the LAF window by pledging government bonds. They are required to invest at least 24% of their lendable funds in government bonds; this portion of their deposits is called the statutory liquidity ratio, or SLR. In view of the tight liquidity conditions, RBI reduced the SLR by 1% to 24% on 1 November. RBI also said on Friday that if a bank did not hold enough government securities to pledge, it would consider relaxing the SLR requirement if the bank approached it.
The use of swaps helps banks avail cheaper funds for buying dollars because they can now borrow from the repo window of the central bank at 7.5%. Repo is the rate at which RBI lends to banks. Earlier, banks would convert their rupee deposits raised at a costlier 10.5-11% into dollars.
“This will ease the pressure on the domestic liquidity and is a positive for money market yields,” said J. Moses Harding, head of wholesale banking at IndusInd Bank Ltd. However, he warned, this would also push the forward premium higher.
Harihar Krishnamurthy, head of treasury at Development Credit Bank Ltd and S.S. Raghavan, head of treasury at IDBI Gilts Ltd said the measures would not impact the forex and bond markets much because they apply only to large banks with overseas operations.
“Right now, there is no need for this action as liquidity has improved after RBI’s measures, but this is a proactive step in case liquidity again becomes tight,” said Raghavan of IDBI Gilts, a firm that trades in government bonds.
In the last month, RBI has cut the cash reserve ratio, or the amount banks are required to keep with the central bank, by 350 basis points to 5.5%. It has also reduced its key policy rate by 150 basis points to 7.5% and SLR by 100 basis points to 24%.
Among state-owned banks, State Bank of India has the largest overseas network. ICICI Bank Ltd is the private sector bank with the largest number of offices overseas.