Mumbai: Banks lined up to borrow short-term funds on Friday, following the central bank’s decision to reduce short-term bank borrowing rates.

Twelve banks borrowed a total of 6,587 crore in bulk deposits, maturing in two months to a year, from the certificate of deposit (CD) market, and bankers said more are likely to follow.

CDs are money market instruments issued for a period of not over a year. The average interest rate on CDs for banks fell sharply from 10.61% on 16 September to 9.71% after the Reserve Bank of India’s (RBI’s) mid-quarter monetary policy review on Friday.

Expectations are that the short-term rates will fall further as RBI’s operating lending rate for banks moves lower.

Ashish Parthasarthy, treasurer of HDFC Bank Ltd, said he expects short-term CD rates (maturing in three months) to fall by 50-100 basis points (bps) in two months. One bps is one-hundredth of a percentage point.

“Rates are already cooling off. In the last couple of days, short-term rates have moved down to 9.50% from their highs of around 11%. As RBI reduces its interest rate on the marginal standing facility (MSF), I think (CD) rates will come down," he said.

Under MSF, banks can borrow from a special RBI window by paying a higher rate when the liquidity in the system is tight.

In July, RBI hiked the MSF rate by 200 bps to 10.25% and capped the amount of money that banks could borrow from its repo window to just 0.5% of their total deposits.

Consequently, the overnight borrowing rate for banks moved up to 10.25%, making short-term money more expensive for banks.

On Friday, RBI cut the MSF rate by 75 bps to 9.5% and governor Raghuram Rajan committed to bringing it down further to reduce the difference between the MSF rate and repo rate (at which the central bank lends to commercial banks) to 100 bps from 200 bps now.

Hitendra Dave, managing director and head, global markets, India at Hongkong and Shanghai Banking Corp. Ltd, said the money markets expect the short-term rates to fall as sought by RBI.

“The governor has clearly said that short-term rates are too high and there is a need to bring down the funding cost for banks. So as soon as the 0.5% cap on the repo borrowing goes, I expect rates to come down," Dave said.

In his post-policy interaction with journalists, Rajan said, “The calibrated withdrawal will reduce the financing distortions that are emerging in the market, and reduce the strain on corporate and bank balance sheets. We have also announced an intention to return to normal monetary operations where the repo rate will return to being the effective policy rate and liquidity conditions need not be as tight as they currently are."

However, short-term rates are unlikely to fall in a hurry because liquidity in the banking system is still tight.

On Thursday, banks paid 10.25% to borrow 81,084 crore from RBI through the MSF window. This was over and above the 40,036 crore borrowed at 7.25% from the repo window. Data on borrowings by banks through MSF is released by RBI with a day’s lag.

Ananth Narayan, co-head, wholesale banking, South Asia at Standard Chartered Plc, said he expects three-month CD rates to fall to 8.75-9% in a few weeks as RBI moves to reduce overnight borrowing costs further.

To be sure, three-month CDs have come off to 9.80% on Friday from a multi-year high of 11.81% on 30 August. It was averaging 10.60% in the week ended 13 September.

Mohan Shenoi, treasurer at Kotak Mahindra Bank Ltd, expects the MSF rate to drop to 9% by December, and the repo rate to be hiked from 7.5% now to 8%.

“RBI has clearly communicated that short-term rates should come down while long-term rates have to stabilize or remain elevated. The market will adjust to that view in the next few weeks," Shenoi said.

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