Mumbai's financial sector has witnessed a significant recalibration as a once-popular deposit product—the Japanese yen (JPY)-linked special deposit—loses momentum following regulatory scrutiny and shifting bank strategies. These fancy financial instruments, heavily marketed to attract non-resident Indian (NRI) funds and appease analysts with attractive yield spreads, are now undergoing a correction. The Reserve Bank of India (RBI) has reportedly advised certain banks to ensure the interest rates offered on such deposits align more closely with actual market conditions. This move comes in the aftermath of the recent shakeout involving IndusInd Bank, which had been a prominent player in this niche offering.
Special JPY deposits were notably popular due to their ability to provide higher-than-usual returns to NRIs. Banks promoted them as innovative instruments under what came to be known as "premium rupee plans" or PRPs. Under these arrangements, NRIs deposited foreign currency, primarily yen, while banks guaranteed a fixed rupee return at maturity. This upfront rupee amount was determined using the forward premium on the yen, enabling banks to offer what appeared to be attractive returns without necessarily increasing their base cost of deposits.
Yes Bank, one of the lenders that also offered these deposits—albeit at a smaller scale compared to IndusInd—has recently slashed the interest on its JPY fixed deposits. From rates that were once over 2% two months ago, Yes Bank has brought them down to under 0.4%. While the bank has not explicitly confirmed if the RBI directed this change, it stated that it regularly reviews interest rates to remain competitive and aligned with evolving market dynamics and industry norms, including adjustments to foreign currency deposit rates such as those in JPY.
The mechanism behind these PRPs was relatively complex. Banks received foreign currency from depositors and repaid them in rupees, locking in the conversion rate in advance. What made the JPY deposits more lucrative was the forward premium that Japanese yen commanded in the interbank market, a result of Japan’s persistently low interest rates. To generate better returns, banks sold yen in the forward market, which provided a high premium and therefore the room to offer more attractive rupee equivalents to NRIs.
Technically, the cost of these deposits included the base rate of around 2% plus the premium the bank paid for purchasing yen forward. However, in banking practices, this premium was not accounted for in the official cost of deposits. As a result, the reported cost appeared artificially low, which not only attracted more deposits but also impressed shareholders and analysts with what seemed to be a highly efficient use of funds.
The RBI’s discomfort with these practices appears rooted in the disconnect between the apparent and actual cost of funds. Regulators are reportedly concerned that offering JPY rates disconnected from market realities presents an unsustainable model for attracting deposits and potentially distorts the broader financial market. A bank offering an out-of-market basic rate undermines consistency across the sector, especially since the forward premium for JPY is standard for all players, driven purely by market forces.
Going forward, PRPs are expected to continue in other currencies like the US dollar, but the specific allure of yen-linked deposits will diminish. The yen had previously been the currency of choice for these schemes due to its high forward premium, which helped banks engineer better returns for customers while still appearing cost-efficient on paper. With that advantage being curtailed by regulatory pushback, banks may have to reconsider how they structure such offerings.
Authorities still recognize the need for maintaining foreign exchange inflows, and as such, are unlikely to eliminate the PRP framework entirely. However, the days of exploiting the forward premium of the Japanese yen to offer eye-catching returns seem to be numbered. This shift signals a broader move towards transparency and market alignment in the structuring of financial products for NRIs.
In essence, the tightening of oversight on JPY-linked special deposits represents an important moment of correction in the banking sector. As banks recalibrate their offerings in response to regulatory cues and market forces, depositors may need to re-evaluate the comparative value of such schemes. For the banking system, aligning with realistic market-based costs enhances long-term sustainability and protects both institutions and depositors from exposure to overly aggressive strategies.
