Fund-strapped banks offer 9.2% on 1-yr paper

MUMBAI: Fund-starved commercial banks are raising one-year money at rates higher than the returns on 10-year public sector bonds, causing a market aberration called `inverted yield curve’.

With deposits from households and businesses yet to pick up, banks are forced to mop up bulk money to plug mismatches in their books and tide over the liquidity crunch. “They are betting that the problem is temporary. No one wants to lock in high-cost funds for a long period,” said a senior trader with a leading financial institution.

On Tuesday, banks offered 9.2% on one-year certificates of deposit (CDs) they issued. CDs are instruments with maturities between seven days and one year that banks float to raise short-term money. On the same day, bonds of triple-A rated government-owned entities traded at 8.95%.

There has been a 65-basis-point rise in one-year CDs in the last one month as against 20 basis points in 10-year public sector bonds. “There is demand for public sector bonds from retirement funds, which prefer long maturity papers that offer more than 8.5%,” said the trader.

Bond yields fall as bond prices go up. A negative or inverted yield curve reflects an interest rate environment in which long-term debt instruments have a lower yield than short-term securities of the same credit quality. “An inverted yield curve signals a lower interest rate in future. It has happened in the past. At present, there is a feeling that short-term money may be expensive, but markets will calm down after some time,” said a banker.

Corporates, on the other hand, raised three-month commercial papers (short-term instruments like CDs) at 9.25%, and six-month CPs at 9.625%. “Even though the Reserve Bank has said it is a frictional liquidity problem and not a structural one, it’s a cause for concern. The government is not spending money and RBI is stuck with Rs 65,000-75,000 crore,” said the head of fixed income at a domestic brokerage.

Banks have borrowed an average of Rs 78,300 crore this quarter from the RBI overnight window as against Rs 23,900 crore in the previous quarter. Analysts fear that liquidity will further tighten in mid-December when over Rs 50,000 crore will flow out of the banking system on account of advance tax payments. The market will also have to absorb CD redemption of around Rs 1 lakh crore by the month end.

“So far, RBI’s measures have been piecemeal in nature. It’s clearly aimed at yield management to ensure that the government’s borrowing costs do not rise beyond a point,” said the treasurer of a private bank. On Monday, the central bank trimmed the size of government bond auctions and announced open market operations—steps that could release Rs 17,000 crore. While government yields fell following the announcement, there has been no significant improvement in liquidity.

The country’s largest lender, State Bank of India (SBI), raised returns on one to two-year deposits by 100 basis points to attract funds. “At 8.5% in the 1-2 year maturity bucket, SBI’s deposit rates are higher than those offered by peers. With the leader setting the tone, others are expected to follow,” said a report from Edelweiss. The move is expected to push up lending rates after some time.