Following a warning by the Reserve Bank of India of a regulatory breach, a number of foreign banks have been forced to unwind billions worth of profitable currency trades. It involved the banks converting rupee-denominated deposits into dollars that were used to buy foreign sovereign debt, including US Treasuries.
Some lenders had racked up exposures of more than $1 billion each by using a regulatory loophole created in February to convert rupee deposits into dollars using a buy-sell swap. The banks used the proceeds to purchase US government debt and profited from the arbitrage, paying around 3.5% on the local currency deposits and earning 4.9% on the 12-month yield on the currency pair.
According to a Bloomberg report, the RBI said the banks must limit their holdings of such unlisted securities to no more than 10% of investments classified as the non-statutory liquidity ratio portfolio. As part of its intervention strategy, the central bank had been offsetting its dollar purchases in the spot market by entering into sell-buy swaps in the forwards markets. The report highlight that, that had swelled RBI’s forwards book to over long $70 billion, causing dollar/rupee forward premiums to spike and foreign banks to book arbitrage gains from the trade earlier in the year.
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Indian entities, as per the US government data, were net buyers of almost $3 billion worth of Treasuries over April and May. The biggest beneficiaries of the swap trades had been overseas lenders in India, which have easy access to large dollar investments. Sources said the banks are in the process of unwinding the trade. “They are selling Treasuries and conducting sell-buy swaps, selling the greenback and agreeing to buy at a later date specified in the contract.”
The report pointed out that the impact of the unwinding was visible in the forward dollar-rupee rate.
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