Indian banks have left a large part of their future interest payments on the $127.23 billion of FCNR(B) deposits they mobilised under the Reserve Bank of India’s special scheme unhedged.

This has opened the lenders to risk in a scenario if the rupee weakens as that can compound fresh dollar demand.

While the RBI's special swap facility protects banks against exchange-rate risk on the eligible FCNR(B) deposits' principal amounts, lenders will need to manage interest payments.

Foreign banks are largely hedging exposure while most state-run banks and several private-sector Indian ⁠lenders have not, Reuters reported quoting bankers.

One banker at a mid-sized state-run lender said their bank had decided not to hedge the interest-payment FX exposure for now, citing the high cost and recent comfort provided by the RBI's intervention-driven rupee rally.

Some lenders have opted to buy dollars in the spot market when the interest payments fall due rather than bear the cost of locking in an exchange rate today.

Hedging the foreign-exchange risk on interest payments for deposits of 3- to 5-year tenors would cost banks about 3% a ‌year, accounting to bankers cited by Reuters. For such deposits, the interest is paid at maturity rather than periodically.

The head of FX trading at a private-sector bank said the cost of hedging is prohibitive, particularly given how recent RBI intervention has made risk-reward on the rupee "asymmetrical."

Positive developments are more ⁠likely to trigger a large rupee rally than negative news is to weigh on the local currency, he said.

The rupee, which rose to a two-month high in the week amid amid persistent RBI intervention and influx of FCNR(B) deposits, could be tested with Brent crude oil prices again approaching $100 a barrel and the possibility of a rate hike by the US Federal Reserve next week.

With at least half ⁠of banks' interest-cost exposure unhedged, renewed rupee weakness could trigger a rush for dollars. A move toward 96-97 per dollar could shift banks' limited inclination to hedge, the news agency reported quoting a banker who heads FX trading at a private-sector bank.