FCNR(B) Deposits and RBI’s Swap Facility: Strengthening Reserves While Managing Currency Risk
Context
In June 2026, the Reserve Bank of India introduced a special swap facility to encourage banks to mobilise FCNR(B) deposits from NRIs amid pressure on the rupee and the need to strengthen foreign-currency liquidity. The response exceeded expectations, with banks mobilising more than $127 billion, against an initial target of around $50 billion. The window for fresh FCNR(B) deposits was subsequently closed on 31 August 2026.
The measure has strengthened India’s foreign-exchange position, but it has also highlighted an important issue: the currency risk has not disappeared; rather, a substantial part of it has shifted between the RBI and commercial banks.
What are FCNR(B) Deposits?
Foreign Currency Non-Resident (Bank) deposits are term deposits maintained by NRIs with Indian banks in permitted foreign currencies.
Unlike ordinary rupee deposits:
- The principal and interest are denominated in foreign currency.
- NRIs are protected from rupee fluctuations on the deposited principal.
- Indian banks obtain an additional source of foreign-currency funding.
- During periods of pressure on the rupee, these deposits can help increase the availability of foreign currency within the banking system.
The special RBI facility was intended to make such deposits more attractive to banks by reducing the exchange-rate risk associated with the principal repayment.
How Did the RBI’s Swap Facility Work?
The key feature was the transfer of principal-related currency risk from commercial banks to the RBI through the swap mechanism.
Banks mobilised foreign currency through FCNR(B) deposits, while the RBI provided a swap arrangement that substantially insulated them from adverse exchange-rate movements affecting the principal.
Consequently, if the rupee weakened significantly during the maturity period, banks would not face the full additional rupee cost of repaying the foreign-currency principal.
The protection, however, comes at a cost. Estimates cited by financial institutions put the RBI’s hedging cost at around 3%, with SBI Research also using approximately 3% annually in its calculations.
Thus, the facility can be viewed as a mechanism in which:
NRIs → FCNR(B) deposits → Indian banks → foreign-currency mobilisation → RBI swap support → reduced principal-related FX risk for banks
How Can the RBI Offset the Cost?
The RBI’s exposure is partly supported by the foreign-currency assets generated through the mobilisation of these deposits.
According to SBI Research estimates, the RBI had accumulated around $31.2 billion in foreign-currency assets by 7 August 2026, equivalent to roughly 55% of the amount mobilised at that stage.
These assets can potentially be invested in overseas securities and other reserve assets to generate returns.
BofA Securities estimated potential returns of around 4.5–5% on the additional foreign-exchange reserves. Therefore, if:
- Hedging cost ≈ 3%
- Return on foreign assets ≈ 4.5–5%
the income generated from the assets could partly or substantially compensate for the cost of the swap arrangement.
SBI Research, assuming mobilisation of about $65–70 billion, estimated a notional annual hedging cost of approximately $2.1 billion. If maintained for five years, this could amount to about $10.5 billion, although the actual cost would depend on market conditions and the evolution of the swap arrangement.
Even such an amount needs to be viewed against India’s foreign-exchange reserves, which were around $700 billion, providing substantial overall reserve capacity.
Why Does Currency Risk Still Matter for Banks?
The RBI’s protection primarily addresses the principal amount. It does not automatically eliminate the foreign-exchange exposure associated with interest payable to depositors.
For example, consider a bank with a $1 million interest liability:
- At ₹95/$ → liability = ₹9.5 crore
- At ₹100/$ → liability = ₹10 crore
A depreciation from ₹95 to ₹100 per dollar would therefore increase the bank’s rupee requirement by ₹50 lakh.
A bank that has hedged this exposure can limit the impact. An unhedged bank, however, may have to purchase dollars at the prevailing exchange rate when the payment becomes due.
This distinction is crucial: the RBI swap reduces the banks’ principal-related currency risk but does not make their entire FCNR(B) exposure risk-free.
Why Might Banks Leave Interest Exposure Unhedged?
One major consideration is the cost of hedging.
For foreign-currency exposure extending over three to five years, hedging can itself be expensive, with estimates of roughly 3% annually.
Banks therefore have to weigh:
Cost of hedging today vs. potential currency loss at maturity.
Some foreign banks have reportedly preferred to hedge their exposure, whereas several public-sector banks and some private Indian lenders have left portions of the interest exposure unhedged.
An alternative strategy is to purchase dollars from the spot market when the interest becomes payable. This avoids the immediate cost of long-term hedging but leaves the bank exposed to a potentially weaker rupee in the future.
What if the Rupee Depreciates Sharply?
The issue becomes more significant when several banks have large unhedged foreign-currency interest obligations.
A sharp depreciation could:
- Increase the rupee cost of servicing FCNR(B) interest liabilities.
- Encourage banks to purchase dollars in the foreign-exchange market.
- Increase demand for dollars.
- Potentially add to short-term depreciation pressure on the rupee.
Thus, the facility reduces systemic currency risk but does not eliminate it. Part of the exposure remains embedded in banks’ future foreign-exchange obligations.
Significance for India’s External Sector
1. Augmentation of Forex Reserves
The mobilisation of foreign currency strengthens India’s reserve buffer and improves its ability to withstand external shocks.
2. Greater Foreign-Currency Liquidity
Indian banks gain access to a larger pool of foreign-currency funding, reducing dependence on alternative external funding channels.
3. External Shock Absorption
Higher reserves provide greater protection against:
- Crude oil price increases
- Sudden capital outflows
- Global monetary tightening
- External financing pressures
4. Confidence in the External Sector
A stronger reserve position can improve market confidence in India’s ability to meet external payment obligations and manage periods of exchange-rate volatility.
Key Risks
The facility nevertheless creates two different layers of exposure.
For the RBI:
The central bank assumes substantial currency exposure through the swap arrangement and therefore faces a contingent financial cost.
For Banks:
Institutions that do not hedge their FCNR(B) interest obligations remain vulnerable to future rupee depreciation.
The broader concern is therefore not simply the size of reserves, but how the foreign-exchange risks created in building those reserves are distributed and managed.
Way Forward
- Strengthen bank-level risk management: Banks should closely monitor foreign-currency asset-liability mismatches and maintain appropriate hedging strategies.
- Improve transparency: The RBI should clearly disclose the costs, returns and contingent exposures associated with such swap operations.
- Maintain adequate reserve buffers: Reserve accumulation should continue to support external-sector resilience without creating excessive central-bank exposure.
- Reduce structural vulnerabilities: Greater export diversification, energy security, stable capital inflows and prudent external-debt management can reduce India’s underlying dependence on external financing.
- Encourage prudent hedging: Banks should assess the cost of leaving foreign-currency interest obligations unhedged, particularly when maturities are long and exchange-rate uncertainty is high.
Conclusion
The 2026 FCNR(B) initiative demonstrates how the RBI can use financial-market instruments to mobilise foreign currency rapidly during periods of external pressure. Its success in attracting more than $127 billion highlights the strength of NRI confidence and India’s external-sector fundamentals.
However, accumulating foreign currency is only one part of external-sector management. The distribution, pricing and hedging of currency risk are equally important. The experience therefore reinforces the need for India to combine adequate forex reserves with sound bank-level risk management and policies that address structural external vulnerabilities.
Source : The Hindu