Earnings from forex swaps
MUMBAI: Even as banks are set to book losses on their bond-portfolios, rising interest rates will help them show higher returns on their forex swaps. The recent rise in forward premia will enable banks supplement forex earnings. Market participants believe that this rise in returns from forex activities will soften the negative impact of losses on account of rising bond yields.
Forward premium — the price for future delivery of a currency, has been rising since January and the positive effect of this is now showing in banks’ forex books. Bankers estimate that profit from forex will rise by up to 25% in the April-June quarter compared with the previous quarter.
When the forward premia is high and the market is volatile, banks tend to collect more from the importer and pay relatively less to the exporters and thereby make money on larger spreads as compared to a situation when the premia are relative low and less volatile. Forward premia on near term contracts have risen considerably since March. For instance, the premium for one month contract has risen from 3.5% in March to 6.6% in June, while premia on the three-month contract has risen from 2.75% to 5.8% in the same period.
At the same time, bond yields have risen by 130-150 basis points across the board. This rise in yields is clearly going to hit banks’ treasury profits this quarter. The losses for the entire banking sector is expected to be in the range of Rs 2,000 crore.
Banks generally hold foreign exchange on their books as a part of their NRI deposits or their tier-I capital. Also, banks have the option of entering into buy/sell swaps — whereby they buy dollars from the market with a stipulation to sell them at a later date, say three or six months. Banks can then deploy these dollars with corporates, at spreads of about 500 basis points above Libor, depending on the rating of the borrower.
Banks get these dollars at a rate of 7.5% and therefore need to ask for spreads of 500 points above Libor — which is around 3% — in order to get a yield of over 8%. However, since this is an expensive proposition, it is not very popular.
“There will be some amount of gain for banks. Those which would have entered positions in sell/buy swaps will gain from the rise in forward premia,” said an official with a foreign bank. In a scenario of rising rates and losses being booked on their G-Sec portfolios, banks also have the freedom of taking positions in overnight index swaps (OIS). These swaps are used to hedge against, or speculate on, moves in overnight interest rates.
“While NRI-deposits have not shown much growth in the past few months, banks can raise 25% of their tier-I capital in foreign currency, all of which is generally swapped out,” said Agam Gupta, Standard Chartered Bank’s head of forex and derivatives trading for South Asia. “Forex swap rates have gone up considerably in the past month, and all banks holding such swaps would have booked a profit,” he added.
