The Reserve Bank of India (RBI) recently opened a special window to boost foreign currency inflows. Under this scheme, the RBI handles the hedging cost (insurance against exchange rate changes) for banks that collect fresh Foreign Currency Non-Resident (Bank) or FCNR (B) deposits for a 3-5 year period. However, small and mid-sized private banks are finding it hard to compete with larger players for these dollars.

At the heart of the issue is 'leverage.' Large banks with branches in foreign countries or in GIFT City (India's special financial zone in Gujarat) can easily lend money to Non-Resident Indians (NRIs). These NRIs then take that borrowed money and put it back into the same bank as an FCNR (B) deposit. This allows a customer to park much more money than they actually have. For example, some large banks offer up to nine times the deposit amount as a loan. Small banks like CSB Bank, City Union Bank, and Bandhan Bank do not have these international branches, making it difficult to offer such loans.

To try and get around this, small banks can issue a Stand-by Letter of Credit or SBLC (a guarantee that the bank will pay if the customer fails). They give this to a foreign bank so the foreign bank can lend to the NRI. But this creates a 'roll-over risk.' Foreign banks usually only lend for one year, while the deposit must stay for three years. If the foreign bank refuses to renew the loan after a year, the NRI is in trouble, and the Indian bank might have to pay up on its guarantee.

Foreign banks also perform their own 'due diligence' (background checks) on the customers. Even if a small Indian bank gives a guarantee, the foreign lender will still take time to investigate the NRI's finances. This causes delays in getting the money. Because of these extra steps and risks, most wealthy NRI customers prefer to go to large banks that can handle everything under one roof.

Market experts like Deep Mukherjee from BCG India note that credit ratings also matter. Overseas depositors feel safer putting their money in large, highly-rated banks. Banks with lower ratings might have to offer much higher interest rates to attract anyone. Currently, the difference in interest rates between India and the US has narrowed to about 2% (200 basis points). This makes it less profitable for investors to move money to India unless the banks offer very high returns.

To fight back, smaller banks are offering very high interest rates. Bandhan Bank, for instance, is offering up to 7.1% on large dollar deposits. In contrast, State Bank of India (SBI) is offering between 5.25% and 6.00%. The RBI has helped all banks by removing the CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) requirements for these specific deposits, meaning banks don't have to keep a portion of this cash idle.

Bankers should watch if the RBI extends the special swap window beyond the current deadlines. For staff at smaller banks, the challenge will be convincing NRI clients to deposit funds based on high interest rates alone, without the benefit of easy offshore loans. Larger banks will likely continue to dominate the FCNR (B) market due to their global footprint and ability to provide instant leverage.