Bank deposit rates headed back south

Private sector bank Kotak Mahindra Bank Ltd has stopped paying a 10.5% annualized return on its one-year deposits. In the public sector banking industry, Delhi-based Punjab National Bank (PNB) has recently withdrawn a special deposit scheme that offered 9.5% interest for one-year deposits while Chennai-based Corporation Bank is no longer paying 10.5% interest on bulk deposits.

“We took a close look at the cost of funds and decided to stop offering 10.5% annualized rate. We have cut the rate by about a quarter percentage point," says Deepak Gupta, executive director, Kotak Mahindra Bank. PNB chairman K.C. Chakrabarty offers a similar logic for withdrawing the special deposit scheme. “There is no concern on the liquidity front and we don’t need to pay very high rates to attract deposits," he says. Corporation Bank CEO B. Shambamurthy says his bank has stopped paying high rates on bulk desposits and will take a look at retail deposits in due course.

In the last week of May, the cost of overnight money came down to a historic low level of 0.01%. Now, the downward movement is seen across the spectrum in the financial markets with year-on-year credit growth dropping to 26% after maintaining around 30% growth for three successive years. “I am seeing a softness even for loan rates. The short-term loan rate for corporations has gone down by at least half a percentage point from around 11% to 10.5% over the last one month," says the CEO of another large bank who does not wish to be quoted. Some bankers say the sellers’ market is slowly turning into a buyers’ market, with borrowers bargaining hard and forcing banks to bring down interest rates for short-term loans.

The trend is best reflected in the certificate of deposit (CD) and commercial paper (CP) markets. The cost of one-year CD that was 10.7% in April came down to 9.2% at June-end. On Monday, the rate fell further to 8.7%. A CD is a promissory note issued by a bank and, unlike a fixed deposit, a CD is a rated instrument that can be traded. The value of outstanding CDs in the Indian banking system is around Rs1 trillion.

With the sharp drop in the CD rate, the spread or the interest rate differential between a one-year CD and a 364-day treasury bill (T-bill) of the Government of India has shrunk from close to 3 percentage points in March-April to a little over 1 percentage point now. “The shrinking spread signifies easy liquidity in the system as well as slowdown in credit growth," says B. Prasanna, senior vice-president of ICICI Securities, a primary dealer that trades in government bonds.

CDs normally offer a slightly higher yield than T-bills because of the higher default risk for a bank, but the spread widened by a large margin in March and April when liquidity was drying up in the system following a series of measures by the Reserve Bank of India.

CPs are an unsecured, short-term loan issued by a corporation. Smart firms normally roll over short-term CPs and meet their working capital requirements through this instrument. It is usually issued at a discount, reflecting current market interest rates. The maturity of a CP varies between three months and one year. The rate of a three-month CP which was 10.6% at April-end, is now around 8.25%.

With the inflation rate coming down sharply to 4.03% and RBI continuing with its dollar buying in the foreign exchange market, ICICI Securities’ Prasanna does not see any immediate change in the interest rate outlook. With every dollar RBI buys from the market (to stem the appreciation of the rupee against the greenback), an equivalent amount of rupee liquidity flows into the system.

A recent HSBC report, too, says “RBI has finished raising rates for the time being". A Merrill Lynch report, released on Monday, also says that “there has been a significant moderation in RBI’s liquidity bias." The report, authored by Ashish Agarwal, says: “The comfort from lower inflation numbers and softer credit numbers could continue in the near term and this could prompt RBI to continue in this move for a little longer."

However, all bankers are not convinced that “soft rates" are here to stay. “The undertone of credit offtake is still very bullish. What we are seeing today could be a temporary phenomenon," cautions Canara Bank chairman M.B.N. Rao.

Rao does not feel that deposit rates will go down sharply as banks need to raise liabilities to meet the credit demand.

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