Banks resort to 1-year CDs on rate hike expectations

Several banks have borrowed large sums through one-year certificates of deposit (CDs), expecting yields to rise as the Reserve Bank of India (RBI) is likely to signal higher rates in upcoming policy reviews.

"There is more interest from banks for one-year CDs due to a hawkish view on interest rate movements in the next one-year," said Ashwini Kumar, a dealer of UCO Bank.

"As rates are (relatively) soft now, it seems to be the best time to borrow through CDs," he said.

Last week's one-year CD issue of UCO Bank, State Bank of Saurashtra, State Bank of Mysore and

Industrial Development Bank of India were at rates below levels earlier this year when liquidity was tight.

For example, on Friday, UCO Bank placed one-year CDs at 7.70 per cent as against 7.90 per cent a month ago.

Also, some banks are issuing CDs to refinance maturing CDs, Kumar said.

The 130 basis points spread between three- and 12-month tenors also reflects the rise that could come after RBI's next quarterly review on July 25, and in subsequent ones in late October and January.

"The current one-year CD rate includes, to an extent, a premium, factoring the likely rate hikes by RBI in the next year or so," a dealer with a broking house said.

Last week, top-rated banks issued three-month CDs at 6.40 per cent, six-month at 6.82 per cent and one-year at 7.70 per cent.

On the buy side, CDs have become a preferred investment avenue for mutual funds to match the inflows in their fixed maturity plans, dealers said.

Mutual funds are investing only a part of their assets in one-year CDs to match the maturity of their fixed maturity plans.

"Funds are not locking their entire portfolio but a small portion of it in one-year CDs, as they too are hawkish on rate outlook for the year, and expect rates to rise a little if RBI hikes rates," a dealer with an MF said.

With credit offtake on the rise, for banks CDs have become preferred borrowing option to build deposits.

In the year ended March 31, banks deposits rose 17 per cent or Rs 3.02 trillion compared with a credit growth of 30 per cent or Rs 3.44 trillion.

"CDs are a better option than term deposits because banks can set the tenure unlike term deposits," a dealer with another mutual fund said.

"And for MFs, CDs are a better option to lock in funds, as they can be traded in the secondary market," he added.