Home / Opinion / Views /  A fair deal for bank depositors can aid our bond market

Different strokes for different folks, even for the same products, has been the working model of banks. While this may be true for a multitude of asset and liability products, it is most apparent in bank term deposits, a retail favourite. As per Reserve Bank of India data, bank deposits constitute more than half the country’s total household financial savings. A large number of homes and senior citizens rely on interest income from deposits. But are retail bank depositors getting a fair deal on the rates they’re offered for their blind faith in banks?’

Look no further than the various bank websites that disclose rates for various tenors of term deposits. The preferred tenor for retail depositors (with deposits less than 2 crore) is 12-24 months. For such tenors, most banks would offer interest rates around 7%, with an added incentive kicker of 25-50 basis points for senior citizens. Looks attractive, given that deposit rates were hovering around 5% a few months ago, before RBI’s rate hike cycle began. But is it the case? Banks are, as of date, issuing certificates of deposit (CDs) and taking bulk deposits at rates that are 50-75 basis points higher than those offered to retail depositors. Is that fair? Can we have a product that lets retail depositors also benefit from these higher rates?

Sure, there is. Let’s first be clear about the regulatory framework for CDs. These are negotiable instruments issued in the form of promissory notes, freely tradable among counterparties. Issued in dematerialized form, they are in multiples of 5 lakh and amounts held up to this limit are covered by the usual deposit guarantee. The minimum tenor of a CD is seven days and since it is a money-market instrument, the maximum tenor is 1 year. Banks are permitted to buy back their own CDs before maturity. Without any change in current regulations, let’s see how we can eliminate arbitrage between bank deposits and CDs.

Banks today offer premature withdrawal of deposits with prescribed penalties. The regulator should nudge banks to issue demat CDs (nothing prevents banks from doing so today) in denominations of 5 lakh and credit them to the demat accounts of depositors; if insurance policies can go demat, why not bank deposits? With an explosion in Indian demat accounts over the last few years, this should not pose a problem. Banks should offer to buy back these CDs at the same rates they would under today’s penalty system. Banks should disclose the last traded yield on their CDs on their websites every day. By doing so, the gap between retail and bulk deposit rates would align over a short period of time. There is an added advantage of more timely monetary policy transmission on deposit rates, just like there is no lag in transmission on external benchmark lending rates.

Now, what is in it for all stakeholders? As I said, banks incur no additional cost on offering such a product. Retail investors would, hopefully, get rates better than what they do on retail deposits. The bigger advantage for them would be the benefit of premature withdrawal. There would be other depositors willing to buy CDs at market rates, which would be better than paying a penalty. The deposits would have rolled down the yield curve before premature withdrawal and would almost always realize the initial yield they expected to get even on a reduced tenor. Banks would benefit because the extent of buy-backs would be negligible and the behavioural pattern on these CDs would align with the final maturity of the CDs issued, a material gain in comparison with deposits. It’s a win-win for banks and depositors.

Now let’s explore how we can make this an anchor product for building a domestic market for corporate bonds. The regulator should allow longer maturity for CD issuance. From the current one-year maximum maturity, let banks issue CDs for up to 3 years maturity. From the current minimum denomination of 5 lakh, let’s make it 1 lakh to widen retail access. As the market gains acceptance and traction, we can consider longer maturities and smaller denominations. Banks enjoy the trust and confidence of depositors, and this product would help them invest in their preferred maturities. By lengthening the maturity period, the market for corporate bonds would have another credible credit curve to go by, the bank-yield curve. This curve would be independent, market-determined and transparent, as well as free from other regulatory interventions and priorities that the risk-free curve of government securities (G-secs) is constrained with. RBI has a platform for retail investors to trade G-secs. Why not CDs? The bank yield curve can be used as an indicator for pricing all lending products and could provide banks flexibility in pricing assets in synchrony with changes in the cost of funds. It is possible to develop an index based on multiple bank CD rates for floating-rate products. There can be derivative products linked to such indices that let banks hedge some of risks associated with their business model. The list is endless of what all this product can help achieve.

India’s government and regulators have been working overtime trying to develop a robust corporate bond market. This product has all we need to give a fillip to that market. We already have the regulatory framework and technology infrastructure in place to get this off the ground within a short span of time. This product may pose a challenge in terms of a regulatory overlap, know-your-customer process alignment, taxation, etc. However, it would help banks strengthen the loyalty of retail depositors.

All we need to tell ourselves is ‘Let’s make this happen.’

Srinivasan Varadarajan is chairman, Union Bank of India

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