Off-market cross-currency swaps and synthetic deposits are two interrelated topics I’ve heard circulating among foreign currency movers during my social rounds in recent weeks.

Yes, Virginia, just as there are synthetic products in the physical world—materials manufactured through chemical processes to imitate natural substances—banking has its own version: the synthetic deposit.

“Economical” is the keyword for both. Just as synthetic perfumes often offer lower costs than the natural variety, a synthetic deposit is not an outright deposit but a strategy that generates peso liabilities for a bank at a significantly lower cost.

An off-market cross-currency swap is one such financial product currently all the craze among banks and financial institutions looking to generate cheaper peso funding. At its core, it is an agreement between two parties to exchange interest payments and principal in different currencies.

Instead of a straightforward cash placement, it typically involves combining a short-term instrument with forward contracts or swaps to achieve a tailored return or specific risk exposure.

In simple terms: A client opens a ₱10 million time deposit with a 90-day tenor. The bank, in turn, offers an off-market currency swap at a pre-agreed peso-dollar exchange rate valued on that day, agreeing to buy back the greenbacks from the client upon maturity.

If the foreign exchange (FX) rate at the time of the agreement is pegged at ₱60, but the bank agrees to buy back from the client at ₱65, the settling mechanism is the ₱5 difference. This spread represents the interest income, providing a yield equivalent to a peso deposit.

This transaction allows the bank to generate peso deposits with little to no intermediation cost. It lowers interest expenses because the activity is reclassified as a trading loss, which in turn allows the Net Interest Margin (NIM) to improve significantly.

For the clients, an off-market FX currency swap offers a committed, superior yield on their peso holdings while—crucially—relieving them of the obligation to pay withholding tax.

In our current, intriguing political climate, this is somewhat speculative; only banks and financial institutions with derivative licenses can engage in these swaps.

From what I’ve gathered, these swaps have deeper implications. They may result in lower revenues for a national government in dire need of funds by circumventing withholding taxes.

From my perspective, there is also an accompanying regulatory risk. Not only does this involve a-seemingly-misrepresentation of interest expenses as trading losses, but it could significantly inflate a bank’s NIM—a ratio of utmost importance to financial analysts.

Finally, I believe there should be a level playing field. Currently, only the “big brothers”—banks and institutions with universal banking licenses—are permitted to engage in this activity.