Mumbai: An increasing number of Indian corporations are raising foreign currency loans from local banks and converting them into rupees even as the overall loan growth in the banking system continues to be at a 12-year low.
Firms are finding foreign currency loans cheaper than raising loans in local currency directly because the London interbank offered rate, or Libor, an international reference rate for financial transactions, is attractively low.
Domestic banks raise foreign currency deposits from non-resident Indians, or NRIs, in the form of foreign currency non-resident (FCNR) loans. Currently, banks are paying 2.2-2.5% on one-year deposits. Interest rates on such deposits have come down substantially following the rate cuts by banks. The rate of interest for a one-year FCNR deposit was 3.12% in March.
Banks are lending such resources at 350-650 basis points over Libor, keeping a margin depending on the credit history of the borrower. One basis point is one-hundredth of a percentage point.
The three- and six-month Libor crashed to less than 1% earlier this year. The six-month Libor is now 0.4925%, and three-month 0.266%.
This, however, does not mean that the top-rated corporate borrowers are getting three-month loans at 4%.
This is because banks insist that the borrower must book a forward dollar contract to hedge the position. Since the three-month forward dollar now costs 2.3%, the cost of a three-month foreign currency loan for a top-rated customer works out to around 6.3%.
At current Libor, if a lower-rated firm takes a dollar loan, the cost comes to around 8.5%, which is much less than what a purely domestic loan would cost.
A senior banker with Union Bank of India told Mint that a firm which would get foreign currency loans at 600 basis points over Libor is eligible for a pure rupee loan at around 11%.
Forward cover is a sort of insurance against currency fluctuations. If the borrower does not take such cover and the rupee depreciates against the dollar, costs will go up substantially as it would need to buy dollars from the market for repaying the loan.
Under Reserve Bank of India norms, it is mandatory for borrowers to buy such forward contracts.
“We are seeing this trend for the last two months. As Libor has fallen to these levels, firms are increasingly asking us to give them such loans,” said a senior official with Bank of Baroda.
According to bankers, the not-so-well-rated firms are looking for such loans more than the top-rated ones, as they are the ones that will be faced with having to pay a higher price.
“Corporates are queuing up for these loans but banks are unable to meet the requirement of clients,” said N.S. Paramasivam, group treasurer of Essar Group. “They are giving the loans on a selective basis.”
“We look at the spread more than anything. If the bank is giving us loans at a lesser spread, this kind of loan always leads to cost savings,” said Paramasivam.
At the end of March, total outstanding deposits under the FCNR scheme stood at $13.21 billion, with another $975 million coming in over the first six months of the fiscal year ending March, according to an RBI publication.
Banks typically use these deposits to give loans to firms for their overseas needs. A portion of these deposits, however, is used for extending domestic loans as well.
Normally these are long-term loans with a reset clause every three to six months, linked to Libor. Firms have the choice of converting such borrowings into rupee loans after each reset.
Because RBI guidelines advise banks to avoid any asset-liability mismatch, they only extend such loans for less than a year because the foreign currency has to be returned to depositors at the end of that period.
Bankers said they deploy only 50-60% of foreign currency deposits for domestic loans. In the past, this limit was rarely reached as Libor was high and there was no cost saving to the borrower after banks added their margin and forward cover as a hedge.
A banker with another large Mumbai-based bank said that given the demand for such loans, lenders are exercising greater caution.
“We are generally giving these loans to our most-preferred customers, who have a good banking relationship with us,” said the banker who did not want to be identified because he is not authorized to speak to the media.
Despite the new-found popularity of such loans, they remain a cause of concern for borrowers because of the volatility of the foreign currencies involved, said Prabal Banerji, chief financial officer of Hinduja Group.
“For bridge loans or working capital needs, these loans are a very effective and cheap way of raising funds,” Banerji said. “But if you are betting on long-term loans based on this strategy, this is very risky. Since it is dependent on external factors such as Libor and foreign currency rates, any volatility in these makes the loan risky for long-term strategy making.”
NRIs can park their rupee deposits with domestic banks through non-resident external (NRE) accounts or non-resident ordinary accounts. They bank their foreign currency funds through FCNR deposits.
RBI has allowed banks to offer Libor plus 1% for FCNR deposits and Libor plus 1.75% for NRE funds.
Banks receive FCNR deposits in US dollars, pounds, euros, yen, Australian dollars and Canadian dollars.
The currency fluctuation risk is taken on by the banks in the case of FCNR; but in the case of other non-resident deposits, the risk is borne by the depositors.