Global banks unwind India currency trades worth billions after RBI warning

 The issue in focus is a flurry of currency swap trades that involved the banks converting rupee-denominated deposits into dollars that were then used to buy foreign sovereign debt

Foreign banks have been forced to unwind billions of dollars worth of profitable currency trades at the behest of India’s central bank, according to people with knowledge of the matter.

The issue in focus is a flurry of currency swap trades that involved the banks converting rupee-denominated deposits into dollars that were then used to buy foreign sovereign debt including U.S. Treasuries, which are unlisted in India. The Reserve Bank of India warned the banks of a regulatory breach last week, saying they must limit their holdings of such unlisted securities to no more than 10% of investments classified as the non-statutory liquidity ratio portfolio.

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 -- buying the greenback now while selling the same amount at a specified date in the future. They then used the proceeds to purchase U.S. 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.

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

The central bank, as part of its intervention strategy, had been offsetting its dollar purchases in the spot market, by entering into sell-buy swaps in the forward's markets. That had swelled its forward's book to over long $70 billion, causing dollar/rupee forward premiums to spike and foreign banks to book arbitrage gains from the trade earlier this year.