Simple products raise the most questions. This appears to be true with my article ‘A fair deal for retail depositors could help the bond market’ published in Mint on 31 January. The article recommended issuing Certificates of Deposit (CDs) to bank depositors for up to three years and indicated the benefits to be derived from doing so. Based on queries from various stakeholders, this follow-up article explains the benefits of CDs. To be clear, bank deposits are the most preferred product for retail investors. The purpose of my recommendation is to take advantage of the ‘most popular’ product and not change any of its features for retail investors. Retail CDs can help create an ecosystem that serves the interests of each stakeholder. I’ll try to explain it through some FAQs.
Do Retail CDs Improve Monetary Transmission?
it sure does. EBLR (External Benchmark Lending Rate) was introduced to ensure monetary transmission on lending rates. Retail CDs will do the same for liability products. The market will price in current and future expectations of policy rates and express them in market levels of CDs. Any change in the trajectory of policy rates will be immediately priced in. The Overnight Indexed Swap (OIS) market is one that is used by the market to price in future rate trajectory expectations. I would argue that a funded instrument such as a CD is a better product for that purpose because it also affects credit offtake expectations.
Do CDs Provide Additional Information About Banks?
RBI has mandated listing of bank equity on stock exchanges to improve disclosure and governance. The same objective would be achieved by having CDs traded widely in the market. CDs from different banks will trade at different levels, and any unusual change in yield will provide the regulator with early information about any changes in the bank’s internals. Offshore markets provide this information to some extent and a vibrant domestic CD market can provide a better indicator on banks’ market sentiment.
Will retail CDs reduce volatility in CD market rates?
Currently, CDs are used to meet the need for funds in excess of retail and wholesale deposit inflows. An increase in the volume of retail CDs would reduce dependence on wholesale deposits and wholesale CDs, thereby reducing volatility in CD rates and market yield movements of wholesale deposits. Retail CDs will improve the stability of the bank’s liability franchises.
Do CDs Need to Be a Money Market Product?
Since banks are allowed to raise deposits of more than one year, they should also be allowed to issue CDs with maturity of more than one year. There is no plausible reason to restrict the duration of a CD, except to force it to fit into the regulatory turf definitions currently in place. deposit guarantee up to CD holders should have Rs 5 lakh available, as is the practice at present.
Are Retail CDs Profitable for Banks?
This. Depositors can put some of their investments in short-term mutual funds into such CDs and the amount raised through them will increase. Therefore, the banks’ cost of funds will be lower and the liability franchise more stable. They will offer buybacks on CDs on the same terms as they offer premature withdrawals with no incremental cost. Furthermore, the market will offer better rates for exits than for premature withdrawals, with the result that buybacks will be used primarily as a backstop facility in exceptional circumstances.
Will NIM volatility of banks come down?
This. At present only lending rates move in synchronism with the policy rates. As with retail CDs, deposit rates will respond in a similar manner, leading to a reduction in borrowing and lending rates. This should reduce NIM volatility for banks and make it more predictable. This will also help analysts better understand the business model and other aspects of the bank.
Are retail CDs like deposits for the customer holding it until maturity?
That’s for sure. There will be no difference for a person holding a CD and a bank deposit, if held to maturity. The CD will be deposited in the demat account of the person who has the additional leverage to sell it when there is a need for liquidity. For depositors who want regular income, banks can think of such instruments which can give them such income.
Will premature withdrawal from CDs benefit customers?
They will almost always have an advantage. For example, if a customer buys a one year CD and wants liquidity after six months, the market will surely give him a better price as the remaining maturity period is only six months. Even if this does not happen, the buyback facility of the bank will ensure that he gets an amount equal to the premature withdrawal.
Is the Retail CD Market Good for the Growth of the Corporate Bond Market?
It definitely is. It is the product with maximum retail participation. Converting a depositor into a CD holder can dramatically improve liquidity in non-SLR markets. The participation of corporate treasuries, intermediaries and aggregators will increase and this will help in multiplying the liquidity for the benefit of individual investors.
Is it cumbersome and difficult to make multiple releases of CDs?
To do this banks definitely need to set up infrastructure and processes. However, regular issuer NBFCs have shown the way in this regard. Banks can issue CDs of 1 month, 3 months, 6 months and 1 year every month with a special ISIN at the beginning of each month. During the month, they can reissue CDs with the same ISIN to the depositors. At the beginning of the next new month, a new series of CDs may be issued with different ISINs.
As we can see from above, a small step in regulation can create innumerable benefits for all the stakeholders. Why delay a product whose time has come? Let’s make it a reality.
Srinivasan Varadarajan is the chairman of Union Bank of India.
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