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Shorter Deposits, Bigger Worries

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On December 19, the State Bank of India (SBI) ran an advertisement about their new ‘unfixed deposit': it could be for anywhere between 7 to 180 days and carried an interest rate of 8.5 per cent, and best of all, could be redeemed at any time (after seven days) without a premature encashment penalty. There is a catch, however: deposits have to be a minimum of Rs 1 crore, a sum far beyond the reach of most.

But consider the features: the interest rate equals the policy repo rate — the rate at which SBI could borrow from the Reserve Bank of India (RBI) — the minimum size of the deposit, and the lack of penalties on premature withdrawal. Beyond the initial seven days, this ‘borrowing' is similar to call borrowing.

Liquidity in money markets, including the interbank overnight market, has been more than a little tight. In its mid-quarter review on December 16, the RBI observed that "consistent with the stance of monetary policy, liquidity conditions have remained in deficit this fiscal year". The only good news was that the RBI did not raise policy interest rates. True, it is helping easing off liquidity through its open market operations or OMO (where the central bank buys back government securities from banks for cash); but not too many banks have a large cushion in their investment portfolios where holdings of government securities exceed statutory liquidity ratios (SLR) of 24 per cent.

Will the SBI's move start a trend among banks? If yes, is at least a part of the money market — the preserve of banks and financial institutions — going retail? True, only high net worth individuals, trusts and similar institutions will be able to provide wholesale-sized deposits. What will that do to the market for other non-money market instruments like certificates of deposit (CDs) and commercial paper (CP)?

Feeling The Blues
Usually, large deposits are acquired through CDs, the preferred instrument of banks to raise big-ticket deposits. The size of that market has been declining steadily, with the total outstanding CDs falling from Rs 4,45,525 crore on April 8, 2011 to Rs 3,82,201 crore on November 4. The tightness in the money market has hit CDs too.

LAXMI IYER Head of fixed income, Kotak Mahindra Mutual Fund

From an average fortnightly issuance of over Rs 50,000 crore at the beginning of this financial year, fresh CD issuance in the fortnight ended November 4 was just over Rs 6,000 crore. Mutual funds, mostly debt funds, are the biggest investors in CDs (and CP, but more on that later). But, as Arjun Parthasarathy, editor of, a portal for financial market investors, says, the ebb and flow of money into CDs is volatile.

And at the end of each quarter, the volatility is most visible. "Advance tax payments and mutual fund redemptions go up," says Killol Pandya, head of fixed income at Daiwa Asset Management in Mumbai. "About Rs 35,000 crore has gone out of the banking system in mid-December towards the former." Another RBI hike would have resulted in a further spike in bond and debt securities yields.

Lack Of Depth
The story with CP — an instrument similar to the CD, but issued by highly-rated companies (CDs must be rated too; only those banks and companies with a rating equivalent to triple A can issue these securities) — is almost the opposite. As banks are reluctant to lend and are struggling to manage higher levels of risky loans, companies that can go to the money market are issuing commercial paper.

"In more than eight months of this financial year, roughly Rs 300,000 crore of CPs have been issued," says D.R. Dogra, managing director and chief executive officer at CARE Ratings. In  2010-11, only Rs 160,000 crore was issued. The maturity of CP, like that of CDs, also ranges between a minimum of seven days and one year.

Like CDs, they are traded in the money markets. "Average trading volume is about Rs 2,500 crore every day," says Anahaita Shah, head of fixed income at NVS Brokerage, a firm that helps clients deal with CDs and CP.

The preference for CP is understandable: it is short term, borrowing is unsecured and helps companies manage cash flow better in turbulent times. It is  cheaper than borrowing from banks. Take, for instance, HDFC that has recently made a CP issue. "We raised Rs 800 crore at a competitive 9.85 per cent for six months," says VS Rangan, executive director, HDFC. "We have been issuing CP regularly because of the attractive rates." Other companies are following his lead, say analysts, and CP issues will continue to be big in the last quarter of FY11.

But as much as analysts seem satisfied with the relative liquidity in both CD and CP markets, as a proportion of outstanding amounts, liquidity is not particularly high — on an annual basis, total traded amounts are less than twice. In the former case, the arbitrage opportunity (about four-tenths of a percentage point, or 40 basis points) between borrowing from the RBI's LAF window and lending in the CD market should drive heavier trading, says a debt broker. But volumes are expected to go down again in mid-January when the pressure of liquidity management for mutual funds goes down.

"All said and done, both the CP and CD market continue to suffer from lack of participants, which results in lack of depth," says Parthasarathi Mukherjee, president (treasury and international banking), at Axis Bank.  The lack of depth results in different pricing for issuers rated similarly. "The absence of two-way quotes and that of a trading platform are other reasons why these two markets lag the much-needed liquidity," says Laxmi Iyer, head of fixed income at Kotak Mahindra Mutual Fund.

So will SBI's unfixed deposit unfix the stuckness in liquidity?  Unlikely. Retail investor participation could be limited as borrowing against a CD is not permitted, and CP issues have no capital protection either. SBI's is an interesting experiment, but once market conditions stabilise, it will be a wholesale market again.


(This story was published in Businessworld Issue Dated 16-01-2012)