Tuesday, December 11, 2007

Certificate of deposits — debt instruments issued by banks — are back in fashion

Certificates of deposits, CDs in short, are used by banks to surge over tight liquidity situations. Corporates usually issue commercial papers for a similar purpose.

Banks have again started issuing certificate of deposits — debt instruments, with banks making a way for raising short-term deposits from the money market. In the first week of December alone banks were able to raise nearly Rs 1,500 crore via issuances of certificate of deposits, as against a total mop-up of Rs 3,115 crore in entire November.

Prakash Subramaniam managing director-South Asia capital markets Standard Chartered Bank said, “Banks do not want to run into an asset-liability mismatch in the first quarter of the new financial year.

Typically, the period between January and March is the busy season for credit and it has always been the case that rates end up spiralling by February-March. Banks have begun building up their books by issuing certificate of deposits for a period of 6 months to an year, in a bid to avoid shelling out higher rates at a later date.”

Treasury managers stated as only four months are left for the financial year to end, the pressure to meet their current year deposit mobilization targets could be a key trigger to force banks for issuing CDs. Banks also deploy this strategy to avoid an asset-liability mismatch at the close of the year.

Despite the fact that CDs are expensive for the issuer-banks, as it has a stamp duty connected such issuances are on the rise. A senior treasury manager explained that when a bank issues a CD directly to an asset management company, the stamp duty works to around 20 basis points of the coupon. If it is routed through another bank, the issuer may have to shell out an additional 5-10 bps.

CDs are flexible and tradable instruments, and hence have greater investor demand. A year ago bulk deposits was a much favored route by the banks. However, these are not tradable instruments and hence, prove to be a costly affair for banks.

A senior dealer from a bond house explained that past one month has seen very few corporates hitting the market with their long-term bond issues, due to the crisis in cash conditions. So, this is one of the reasons why CDs manage to attract investor interest, in the absence of corporate bond issues.

The Reserve Bank of India (RBI) had hiked the cash reserve ratio (the proportion of deposits banks need to maintain as cash with the central bank) by 50 basis points in its mid-term policy review which led to severe strain of cash flows in the banking system.

Further, this month, liquidity could have come under further pressure, due to the outflows on account of advance tax payments. Other entities, which invest in CDs on a regular basis, include bond houses, insurance companies and mutual funds, especially liquid funds which invest purely in money market instruments.

Yields on CDs, which were stable around 7.92% in October, have now risen to 9% levels for one-year tenure, while a three-month CD fetches anywhere between 8.25% and 8.75%.

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