Banks get aggressive on raising funds via CDs
Amidst rising repo rates, Indian banks appear to have discovered a new mode of raising funds from the market. They are raising funds aggressively through certificates of Deposits (CD), which is a short term fund raising method for banks. These CDs are typically a money market instrument and have a maturity ranging from a few days to as long as 1 year. In the last few months, there has been a perceptible increase in the fund raising activity of banks through the issuance of certificates of deposits, as other options have been contracting.
Amidst rising bond yields and repo rates, most banks will have to hike the deposit rates offered. However, that would hike their cost of funds and narrow their net interest margins (NIMs). The other option is to raise funds through CDs, which offers short term funds at extremely competitive rates. You just need to look at the numbers to get a clearer picture. For instance, if you just take the first 20 days of August 2022, PSU and private banks raised close to Rs30,000 crore through the issue of CDs, a record of sorts.
It is not just the small and mid-sized banks that are finding CDs a more profitable and attractive alternative. Even large PSU banks like Punjab National Bank and Bank of Baroda are finding the CD route more lucrative. The reasons are not hard to seek. The cost of raising funds via CDS for a one year tenure ranges between 6.60% and 6.74%, and it is getting increasingly difficult to source deposits at these rates. This at least allows them to tie up funds for one year and give them a cushion in case RBI decides to tighten for longer period.
The current rate of CDs is just about 120 bps above the repo rate of the RBI, which has bene enhanced to 5.40% in the August policy. That is an attractive spread. There is one more reason for this surge in CD demand by banks. Thanks to the persistent tightening via rate hikes, CRR hike and the VRRRs, the banking system liquidity surplus has dropped below Rs100,000 crore. This sudden and sharp fall in liquidity is also pushing the banks more towards the CD route and this phenomenon is likely to continue through 2022.
If supply is one side of the story, there is also substantial appetite for the CDs issued by Indian banks Most of the debt funds have a lot of short term money at their disposal and bank CDs fit perfectly into their portfolio choice. Most of the fund managers are keen to park their surplus funds in bank CDs. This robust demand and supply ensures that the interest in CDs work both ways. The demand and the supply side of CDs are working in favour. More so, since MPC has indicated that the rate hikes may have more legs to it.
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