Banks get trapped in bulk deposits war

2007 THE YEAR THAT WAS: DEPOSITS

It was the first week of March 2007. A top official at the Indian Banks' Association (IBA) was having a discussion with the then two managing directors of State Bank of India (SBI) at the skyscraper headquarters of the country's largest bank.

IBA's agenda was to get SBI to agree to douse the bidding war for corporate deposits, with successive cash reserve ratio (CRR) hikes and continued high credit growth having made banks run helter-skelter for resources.

Interest rates offered on bulk deposits had then touched 12-13 per cent, with a few stray deals struck at ridiculously high rates of even 16-17 per cent. The (CRR) is the amount of deposits banks are required to keep with the central bank. 
 

PROBLEM OF PLENTY
Rs crore	Bank deposits	Change*	Bank credit	Change*
26-Jan	24,04,808	16,417	17,80,632	14,289
23-Feb	24,67,048	62,240	18,20,238	39,606
30-Mar	25,94,259	1,01,406	19,23,192	76,790
27-Apr	26,00,117	5,857	18,89,557	-33,635
25-May	26,08,665	8,549	18,86,520	-3,037
22-Jun	26,68,187	59,522	18,95,801	9,281
*Change over the previous month Note: About 21 per cent of the increase in deposits in 2006-07 (Rs 4,85,210 crore) happened in March 2007 alone.

The attempt failed. SBI wanted a commitment from its immediate rivals that any agreement would be diligently honoured.

There was no way a commitment would be forthcoming from any bank. No one was willing to commit to stay away from the frenzied bidding for deposits as each feared that competitors would grab all the resources available if they did not offer "competitive" rates.

Each bank had its own compulsions and it was advantage companies. IBA at least tried to prevent banks from being fooled by companies into paying rates much higher than what competitors were actually offering.

IBA then compiled and circulated among member banks bids placed on a particular day for the non-card rate deposits (bulk deposits). This was to stop companies from pitting banks against each other to extract higher rates for their deposits.

Banks could not consolidate their attempt not to offer more than 10 per cent for bulk deposits. On March 31, 2007, the closing day for the financial year 2006-07, the overnight rates (the rates at which banks borrow from each other) touched 80 per cent, which in normal times range in single digits.

SBI alone raised Rs 10,000 crore of bulk deposits from the third week of February, at an average rate of 10-10.5 per cent, even raising a small tranche of Rs 50-60 crore at 12 per cent in the second week of March.

Subsequently, the country's largest bank set 10.75 per cent as an internal cap on the rate it would pay for bulk deposits.

A senior official at a large public sector bank said "... there was a deposit rate war. The loan growth was very good.

Public sector undertakings were playing in the market. Deposits were auctioned to the highest bidder. There was a tightening in call rates ranging between 16 and 80 per cent."

Loan growth in the preceding two years had by far outstripped the growth in deposits. In October 2006, while raising the repo rate by 25 basis points, RBI Governor Y V Reddy had warned banks of the consequences of an imbalance in deposit and credit growth, saying that henceforth banks would find it more expensive to raise resources for meeting further credit demand.

The repo rate is the rate at which the central bank lends to banks against government securities. Since December 2006, RBI, in successive moves to tighten the monetary policy, has raised the CRR five times by 50 basis points each to 7.5 per cent. The repo rate has also been raised on three occasions by 25 basis points each taking it to 7.75 per cent.

As warranted by the monetary policy action, interest rates started rising sharply. However, the rise in deposit rates was not the outcome of policy action alone but also due to banks' bid to garner more deposits to fund the continued upswing in credit demand.

The ensuing "rate race for deposits", as described by the chairman and managing director of a large public sector bank, saw banks launch "limited period" special schemes to raise one-year retail deposits at 9.5 per cent.

The normally smooth deposit rate curves of banks then developed kinks with interest rates on longer-term deposits lower than around the one-year deposit rates.

"There was a deposit rate war. Most banks were offering slightly higher rates under special schemes (launched in the first few months of 2007) without disturbing card rates. Banks picked up the most attractive period between 1 and 3 years and gave a narrow bandwidth. There was cannibalisation from the banks' own deposits to these special schemes, but only in that maturity," said a banking analyst.

Besides deposits, banks diluted their excess investments in government bonds to finance credit growth. Banks' holdings of government securities fell to an average of 28 per cent of their total deposits at the end of March 2007 from 31.3 per cent a year earlier.

"Each bank had its own compulsions to raise deposits. There was liquidity, but there was uncertainty as banks were not sure about the monetary policy response," said the treasury head of a large private sector bank. However, the distribution of liquidity was skewed.

Large public sector banks, holding excess government securities over the statutory minimum of 25 per cent of their deposits, borrowed from RBI through its repo window at 7.5 per cent and lent to banks facing a resource crunch at rates as high as 80 per cent.