Date:27/11/2008 URL: http://www.thehindubusinessline.com/2008/11/27/stories/2008112752550600.htm

Back Citi bailout, big relief for banks

Nostro accounts not covered by FDIC, could turn sticky.

A nostro balance is an account that one bank maintains with another bank, a foreign bank, in foreign currency.

C. Shivkumar

Bangalore, Nov. 26 Having spent sleepless nights, public sector banks (PSBs) have reason to be relieved by the US-Government inspired bailout of Citibank.

High level banking sources said that most PSBs’ nostro balances are maintained with Citibank. A nostro balance is an account that one bank maintains with another bank, a foreign bank, in foreign currency. Among the banks holding nostro balances with Citibank are State Bank of India and its associate banks. Citibank is currently the world’s largest clearing bank. This was the major reason for PSBs’ preference for maintenance of correspondent accounts with Citi.

Nostro account balances, however, are not covered by the Federal Deposit Insurance Corporation (FDIC). FDIC insures deposits in US banks and savings institutions. Only US residents are currently covered by the FDIC. Consequently, in the event of bank failures, nostro balances face the risk of becoming sub-standard assets for Indian banks, the sources said.

Private banks

But bankers said that some private sector banks had also held nostro balances with banks such as Wachovia, whose clearing operations were far smaller than Citibank’s. Bankers said the risks were higher in the event of the failure of such banks. Clearing operations are highly profitable operations for US banks. Consequently, even in the event of bank failures, clearing operations are likely to be taken over by other large banks.

However, given the escalation in financial risks in the US, many banks are beginning to limit their exposures. PSBs, the sources said, have begun reducing their nostro balances to the barest minimum. Currently, the nostro balances have been reduced to 1 per cent of the annual export receipts or about $1.5 billion. Till last year, they had maintained balances as high as 5 per cent of the annual export proceeds.

Shifting to US T-bills

Moreover, bankers said some banks preferred shifting to US Treasury bills for limiting risks. This trend was evident from the US Treasury Department data released last week. The data showed an increase in the Indian investments in US Treasuries. Investments in US Treasuries, mostly Treasury bills, were $14.2 billion in September this year, or a $3.7 billion increase over the corresponding period last year. For the first half of this fiscal, the increase amounted to $2.4 billion. The shift took place, despite the drop in the country’s currency reserves, as domestic banks moved out of deposits in US banks and certificates of deposits to safe havens like US T-bills. This was despite the low yields from US T-bills. The three-month US T-bill currently yields only about 0.13 per cent.

However, it was not just banks that were restricting their balances in the US banks. Given the restricted nature of FDIC coverage, large domestic corporates are also beginning to shift to domestic banks to mitigate risks. This was a major factor that was driving up bank time deposits that are currently growing at an annual clip of about 24 per cent.