Depositors now go short

Time deposits of banks amount to Rs 13,28,714 crore, accounting for 61 per cent of the total deposits. 8220;There are uncertainties on the interest rate front. Depositors obviously want higher returns in the shortest time possible,8221; said the chief of a private sector bank.

Besides, the opening up of new investment avenues like mutual funds, stocks, commodity markets and insurance have given depositors various options. 8220;For a five year term deposit, I don8217;t get more than 7 per cent from the bank. I can get ten times of this by investing in a mutual fund or stock market. I get a higher rate of 8 per cent on one-year deposits,8221; said stock dealer Pawan Dharnidharka.

According to the RBI, the increased preference for short-term deposits could be attributed to low returns on long-term deposits. This is evident from the spread between short-term and long-term deposits, which narrowed down to 75 basis points at end-March 2006 from 100 basis points at end-March 2005 before widening a little by June 2006.

In view of low spread, investors prefer short-term deposits, despite low returns, while waiting for investment opportunities with higher returns. 8220;Banks on the other hand, prefer short-term deposits. With low short-term interest rates, banks are able to mobilise resources at lower cost. This enables banks in a competitive environment to lend at lower cost to well-rated business firms to contain defaults on their loans,8221; the RBI says.

Though the government had announced tax sops under Section 80C to term deposit of over five years in the last Union budget, the situation has not changed. 8220;This could be due to the Rs one lakh limit for tax incentives,8221; said an official of a private bank. Seeing the trend, many banks had recently come out with FD schemes with tenures of 390 days and 340 days, offering 8 per cent interest rate.

There are pitfalls also. Short-term deposits and certificates of deposit CDs need to be rolled over every year. 8220;This increases the pressure on the bank to raise resources for meeting the redemption requirements, more so in a high credit growth environment,8221; says a Crisil study.

According to Crisil, if at that point in time liquidity in the market is tight, then the cost of raising these resources increases. Further, the proportion of bulk deposits in short-term deposits has been steadily increasing over the past four years. bulk deposits are typically sensitive to a rising interest rate scenario and therefore volatile, more so since banks typically do not penalise such deposit-holders for premature withdrawals.