The extent of FCNR(B) funds that the foreign branch can borrow and deploy in corporate papers depends on its normal prudential norms and asset liability management functions.

The RBI clarification was made to Bank of Baroda which had written to the central bank in November seeking clarification on the deployment of FCNR(B) funds. Accoring to the RBI rule, FCNR(B) funds can be invested only in highly liquid overseas inter-bank market and US treasuries.

BoB wanted to deploy FCNR(B) funds in more lucrative options in the face of the drop in international interest rates. Lending FCNR(B) funds to its overseas branch will come within the definition of deploying the fund in the overseas interbank market. This way, even though the bankwill have to book a loss on its FCNR(B) funds, it gains ultimately on a net basis by higher profits from its foreign operations.

Some major public sector banks like State Bank of India and Bank of India were already active in the secondary market for Indian papers abroad through their foreign branches. With the RBI clarification in place, now BoB will also start picking up overseas Indian papers through its branches, said a BoB official. He, however, said that the foreign branches will be borrowing FCNR(B) only to the extent permitted by their own capital adequacy and prudential requirements.

The BoB request follows the emergence of negative spread on its FCNR(B) funds. Spread on FCNR(B) funds have turned negative for banks folowing the drying up of domestic demand for FCNR(B) loans as well as the interest rate cut in the international money market. While the average cost of FCNR(B) funds for banks is in the region of 5.5 per cent, the interest rate on US treasuries and six-month Libor, the major avenuefor deployment of FCNR(B) funds, is around 5 per cent. On the other hand, blue-chip Indian papers are available at attractive spreads of over 400 basis points above Libor.

The total size of FCNR(B) funds with banks is $8.46 billion as on March, 1998. Since then the FCNR(B) corpus has not grown much further. In fact, it had fallen a little due to the shift to Resurgent Indian Bond issue in August. SBI has the largest FCNR(B) corpus amounting to more than $3 billion followed by BoB and BoI.