By Suvashree Ghosh and Subhadip Sircar

The Reserve Bank of India’s attempt to flush out excess dollars from the local market has offered a unique arbitrage opportunity for some banks.

Lenders are using a regulatory loophole to make a sizable profit, according to people with knowledge of the matter. A large bank could easily rack up exposures of more than $1 billion using this strategy, multiple traders said, asking not to be identified as the deals aren’t public. Top beneficiaries from these trades are foreign banks, which have large and easy access to dollar stockpiles.

At the center of the strategy is the RBI’s decision in February to remove limits on local bank exposures to other countries and central banks. Governor Shaktikanta Das had been hoping that banks would use their excess dollars to buy U.S. Treasuries, for instance, rather than offload them in the local market where price dislocations were making it costlier for Indian companies to hedge.

The cause of concern was the so-called forward premia — the cost to buy dollars at a future date — which was at the highest level in more than four years. The rate had surged partly because of the RBI’s attempts at intervention: its long-dollar book rose to $47.4 billion at end-January from a negative $4.9 billion in March 2020. Rather than having to buy more dollars, Das wanted to prevent inflows of hot money.

In discussions between officials from the RBI and banks, the RBI made it clear that banks should deploy their own dollars abroad, the people said, though written rules only mention “resources” and don’t define the pool. Banks are using this lack of clarity as a loophole to make profits.

Here’s how it works. A bank converts its rupee deposits into dollars using a buy-sell swap, which means it buys dollars today and agrees to sell the same amount of greenback at a specified date in the future. It uses these dollars to avail the RBI exemption and purchase U.S. Treasuries. The big return is in the arbitrage: at prevailing rates the bank would be paying about 3.5% on its rupee deposit, while the one-year forward premia is 4.9%, netting the bank a cool 1.4 percentage points of profit.

Since there are no longer any limits on how much these banks can invest abroad, there are no limits on how much profit a bank could book.


The trades aren’t illegal and there’s no suggestion of wrongdoing. In fact, the February relaxation has lowered the forward premia to 4.9% from 5.4%.

But officials at the RBI are in a quandry. As the biggest buyer of dollars in the forwards market, the RBI is effectively funding some of these trading profits for banks.

An email to an RBI spokesman was unanswered.

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