Different strokes for different folks, even for the same product, has been the working model of banks. While this may be true for a multitude of asset and liability products, it is most evident in bank term deposits, which are a retail favorite. According to the Reserve Bank of India data, bank deposits account for more than half of the country’s total household financial savings. A large number of households and senior citizens depend on interest income from deposits. But are retail bank depositors getting a fair deal on the rates offered to them for their superstition in banks?’
Check out various bank websites that disclose rates for different tenures of fixed deposits. Preferred Tenure for Retail Depositors (with deposits below Rs. 2 cr) is 12-24 months. For such tenures, most banks will offer interest rates around 7% for senior citizens with an additional incentive kicker of 25-50 basis points. Looks attractive, given that a few months back, deposit rates were hovering around 5% before the rate hike cycle started by the RBI. But is it so? Banks, as on date, are issuing certificates of deposits (CDs) and taking bulk deposits at 50-75 basis points higher than the rates offered to retail depositors. is that fair? Can we have a product where retail depositors can also benefit from these higher rates?
Sure, there is. Let’s first be clear about the regulatory framework for CDs. These are negotiable instruments issued in the form of promissory notes, which can be freely traded between counterparties. issued in dematerialized form, they are in multiples of 5 lakh and the amount placed up to this limit is covered by the General Deposit Guarantee. The minimum tenure of a CD is seven days and since it is a money-market instrument, the maximum tenure is 1 year. Banks are allowed to buy back their CDs before maturity. Without any change in the existing rules, let us see how we can eliminate arbitrage between bank deposits and CDs.
Banks today offer premature withdrawal of deposits with prescribed penalties. Regulator should encourage banks to issue demat CDs (no one stops banks from doing so today) 5 lakh and deposit the same in the demat accounts of the depositors; If insurance policy can be demat then why not bank deposit? With the explosion of Indian demat accounts over the past few years, this should not be a problem. Banks should offer to buy back these CDs at the same rate they would under today’s penalty system. Banks must disclose the final traded yield on their CDs on their websites every day. By doing so, the difference between the retail and wholesale deposit rates will equalize in a short period of time. There is an added benefit of more timely monetary policy transmission on deposit rates, just as there is no lag in transmission on external benchmark lending rates.
Now, what’s in it for all the stakeholders? As I said, there is no additional cost to the banks for offering such a product. Retail investors are expected to get better rates than retail deposits. The big advantage for them would be the advantage of premature withdrawal. Other depositors would be willing to buy CDs at market rates, which would be better than paying the penalty. Deposits will have rolled down the yield curve prior to premature withdrawal and will almost always realize the initial yield they were expected to get even over short periods. Banks will benefit as the extent of buy-back will be negligible and the behavior pattern on these CDs will align with the final maturity of the CDs issued, materializing the advantage compared to deposits. It is a win-win deal for banks and depositors.
Now let us see how we can make this an anchor product to create a domestic market for corporate bonds. The regulator should allow longer maturities for the issuance of CDs. Allow banks to issue CDs for a maturity period of 3 years, from the current maximum maturity of one year. from the current minimum denomination of 5 lakhs, make it 1 lakh to widen the retail reach. As it gains market acceptance and traction, we may look at longer maturity and smaller denominations. Banks enjoy the trust and confidence of depositors, and this product will help them invest in their preferred maturities. By lengthening maturities, the market for corporate bonds will have a more reliable credit curve, the bank-yield curve. This curve will be independent, market-determined and transparent, as well as free from other regulatory interference and preferences that constrain the risk-free curve of government securities (G-Secs). RBI has a platform for retail investors to trade G-Secs. Why not CD? The bank yield curve can be used as an indicator for pricing all loan products and provides banks with flexibility in pricing with changes in the cost of funds. It is possible to develop an index based on several bank CD rates for floating-rate products. There may be derivative products linked to such indices which allow banks to hedge some of the risks associated with their business model. The list is endless as to what this product can help achieve.
India’s government and regulators are working overtime to try to develop a strong corporate bond market. This product has everything we need to promote that market. We already have the regulatory framework and technology infrastructure in place to roll it out in a short span of time. This product may present a challenge in terms of regulatory overlap, KYC process alignment, taxation, etc. However, it will help banks strengthen the loyalty of retail depositors.
All we need to say to ourselves is ‘Let’s make this possible.’
Srinivasan Varadarajan is the chairman of Union Bank of India
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