Mumbai: State-owned Bank of India is offering 0.25% extra interest to long-term depositors who are willing to put money in the bank’s floating rate deposits. The rate of such deposits, linked to the bank’s term deposits, will be reset in the beginning of each quarter.
Bank of India is one of the few commercial banks that are offering floating deposits and not all of them are using term deposit rates as a benchmark for such deposits. Some banks are using yield on government securities, particularly 10-year bonds and 364-day treasury bill, as the benchmark rates.
Tentative moves: A bank branch in Mumbai. Banks are not wooing floating rate deposits aggressively as interest rates may go up more. Photograph: Santosh Verma / Bloomberg
In a rising interest rate scenario, interest rate on floating deposits can go up and yet there aren’t too many takers for such deposits, and banks, on their part, are not aggressively selling such instruments.
They are going slow on garnering such deposits because they need to pay higher interest rates in the future if the benchmark rate goes up. The depositors are not excited about this product as, unlike term deposits, floating deposits has a moratorium and if they want to redeem the deposits ahead of maturity, they need to pay penalty by way of a sharp reduction in returns. Besides, any change in floating deposit rates also makes return on such deposits uncertain.
“The product is yet to pick up in India. Retail depositors want a clear idea of what they are getting when their deposits mature. Floating rate deposits do not give that certainty,” said B. Sambamurthy, chairman and managing director of Corporation Bank.
The Reserve Bank of India, or RBI, allowed banks to offer floating rate deposits six years ago, in 2002, after some banks and financial institutions started redeeming deep-discount bonds floated in mid-1990s when interest rates hit the roof.
These long-tenure bonds, maturing between 15 and 21 years, offered 14-15% interest rates to consumers. They also carried “call” and “put” options, allowing both bond holders and lenders to redeem the bonds at regular intervals. Most of the lenders used the “call” option in the beginning of the century, when the interest rates dropped sharply, to cut the cost of deposits.
Wiser with this experience, banks do not want to lock themselves in for long-term deposits and very few now offer fixed deposits beyond three years.
The banking regulator wanted to solve the problem by allowing banks to offer floating deposits and giving them flexibility on fixing the cost of such deposits. According to bankers, who do not wish to be named, floating deposit rates were introduced to protect banks from long-term high-cost liabilities rather than offering customers a new instrument.
Not surprisingly, customers have never been interested in this product even though it features in most banks’ product portfolio.
“The timing of the product launch was wrong. It got a beating that time and is yet to recover,” said a senior public sector banker who does not wish to be named. In mid-2002, the yield on benchmark 10-year paper was veering around 7.65% but it closed the year at 6.08%. It even dropped below 5% in October 2003. When the outlook on interest rates is soft, people do not want to go for floating deposits.
In a rising interest rate scenario, floating rate deposits look attractive but the yields on the 10-year government paper is anything but stable. The yield on the benchmark 10-year paper, which was 7.76% in the beginning of calendar year 2008 has dropped to 9% now, after touching 9.5% in July.
“The floating rate deposit scheme did not evoke much response as expected because customers want certainty of a steady cash flow,” said an official of India’s oldest mortgage lender, Housing Development Finance Corp. Ltd, one among the few institutions that launched a floating rate deposit scheme in early 2004. “A steady cash flow is the key reason why people go for fixed deposits.”
To make floating deposit rates attractive, some banks introduced flexi-deposit rate schemes. Exim Bank of India, for instance, is offering a deposit scheme where customers get the benefit of rising interest rates, but do not get affected when the rates come down.
Its three-year and five-year floating deposits, launched this year, are benchmarked to yields on comparable maturity government bonds.
“Traditionally, consumers want to crystalize income into a steady cash flow and generally won’t like to take risk of a floating rate system.” said Shankarnarayan R. Rao, executive director of Exim Bank.
“We welcome this product as it gives a better hedge and helps us tackle asset-liability mismatches. But for a customer, who wants to bet on uncertainties, investment in equities is a more attractive option,” said a general manager with a large public sector bank who does not wish to be named.
Banks, however, are quite aggressive when it comes to selling floating rate loans. More than 70% of home loans given by banks are floating rate loans and interest rates on such loans change if when the banks change their benchmark lending rate.