New Delhi [India], September 4 (ANI): Foreign currency non-resident (FCNR-B) deposits are likely to improve banks' return on equity (RoE) despite a marginal pressure on net interest margins (NIM), as exemptions from reserve requirements and the ability to lend against pledged deposits make the funding more capital-efficient, according to a report by Anand Rathi Research.

The brokerage said the FCNR-B scheme has received a strong response since its launch on June 8, with USD 127.3 billion mobilised through FCNR-B deposits and total foreign currency inflows reaching USD 136.4 billion when overseas foreign currency borrowings (OFCBs) and external commercial borrowings (ECBs) are included.

While the market has viewed FCNR-B deposits as potentially NIM-dilutive because their all-in rupee funding cost is higher than domestic funding, the report said the impact on overall margins is likely to be limited.

"We view it as RoE-accretive despite being mildly NIM-dilutive," the report said, adding that the current FCNR-B deposits account for around 4.5 per cent of system deposits. At this level, the brokerage estimates that even a roughly 110 basis point lower spread on FCNR-B funding would translate into only about 5 basis points of impact on blended NIM/spreads.

A key advantage is that FCNR-B deposits are exempt from cash reserve ratio (CRR), statutory liquidity ratio (SLR) and priority sector lending (PSL) requirements. The report said this allows banks to deploy the entire deposit towards higher-yielding non-PSL loans, compared with domestic deposits where part of the funds is tied up in reserves and lower-yielding assets.

The benefit becomes more pronounced when banks use a leveraged structure, where non-resident Indians pledge their FCNR-B deposits and banks lend against them. The brokerage estimates such loans can carry a relatively thin spread of around 50 basis points, but have zero or near-zero risk-weighted assets, resulting in limited additional capital consumption.

"The lending spread is thin, but it is earned on near-zero-RWA assets that consume almost no capital," the report said.

The longer 3-5 year tenor of FCNR (B) deposits could also benefit banks if repo rates rise in the future, as loan yields may reprice upwards while funding costs remain locked in. This could widen spreads and strengthen the returns from FCNR (B)-funded lending, the report noted.

Overall, it said the combination of reserve exemptions, capital efficiency and locked-in funding costs could translate into a "tangible earnings and RoE uplift" as the scheme reaches meaningful scale. (ANI)