State Bank of India took the market by surprise on Tuesday when it raised interest rates on short-term deposits by up to a massive 225 basis points. HDFC Bank also increased interest rates on short-term deposits on Wednesday even as it did not change rates on deposits of over one year.
The fact that banks have begun making short-term deposits more attractive is perhaps an advance warning of a scramble for funds. Some banks—especially a few of the more aggressive ones—have not managed their liquidity very well and have been borrowing overnight money from the Reserve Bank of India to fund their positions, a practice that has upset the central bank.
Smart depositors now have a clear option to keep rolling over their short-term fixed deposits, getting higher returns than the savings bank rate without sacrificing liquidity.
It is quite likely that banks may also try to aggressively seek short-term money from companies, though the latter will continue to find money market mutual funds more attractive because of their tax benefits.
There is also a long-term issue worth considering. Indian depositors have been quite content to leave money lying around in savings deposits that offer very low rates of return, making such money a source of cheap funds for banks. If the differential between the rates offered on savings bank accounts and short-term fixed deposit rate increases, as is happening right now, depositors will have a stronger incentive to manage their money more actively.
Analysts are already asking whether banks will see their costs go up as smart money moves from the so-called current and savings accounts (Casa) to short-term fixed deposits. In a report on Wednesday, DNA Money has cited two such research reports. “When there is such a visible arbitrage opportunity as a depositor, we find it hard to imagine why Casa balances will remain sticky,” says a note from Ambit Capital.
Banks may have to try harder in the coming quarter to maintain their deposit mix in a way that does not see a spike in costs.
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