RBI's Attempt To Flush Excess Dollars Offers Lucrative Trade For Banks

As the biggest buyer of the greenback in the forwards market, the RBI is effectively funding some of the trading profits.

The Reserve Bank of India's attempt to flush out excess U.S. dollars from the nation's markets has offered a unique arbitrage opportunity for some banks. Lenders are using a regulatory loophole to profit from trading in the currency forward markets, according to people with knowledge of the matter. A large bank could easily rack up exposures of more than $1 billion, multiple traders said, asking not to be identified as the deals aren't public. The strategy revolves around a February regulation change that dropped exposure limits local banks have to other sovereign assets, such as U.S. Treasuries, which allowed them to take advantage of a spread in the dollar-rupee markets. The RBI's extensive intervention had driven implied 12-month yields for the currency pair to the highest in more than four years. The biggest beneficiaries have been foreign banks in the nation, which have easy access to large dollar stockpiles, the people said. As the biggest buyer of the greenback in the forwards market, the RBI is effectively funding some of the trading profits. Here's how it works. Banks would convert rupee deposits into dollars using a buy-sell swap -- buying the greenback now while selling the same amount at a specified date in the future. They use the proceeds to purchase Treasuries, under the newly-relaxed RBI rule. The return is in the arbitrage: they pay around 3.5% on local currency deposits, while earning 4.9% on the one-year forward premia.