Retail CDs: Small change, innumerable benefits to stakeholders

Simple products evoke the most questions. That seems true with my article ‘A fair deal for retail depositors can aid the bond market’ published in Mint on 31 January. The article recommended issuing certificate of deposits (CDs) for up to three years to bank depositors and alluded to benefits that can accrue from doing so. Based on the questions from different stakeholders, this follow-up article expounds the benefits of CDs. To be clear, bank deposits are the most preferred product for retail investors. The objective of my recommendation is to leverage the ‘most popular’ product and not to change any of its attributes for retail investors. Retail CDs can help build an ecosystem that serves every stakeholder’s interests. I will try and explain this through some FAQs.

Do retail CDs improve monetary transmission?

It sure does. EBLR (External Benchmark Lending rate) was introduced to ensure monetary transmission on lending rates. Retail CDs will do the same for liability products. Market will price in current and future expectations of policy rates and express them in market levels of CDs. Any changes in trajectory of policy rates will get instantaneously priced in. The Overnight Indexed Swap (OIS) market is the one that is used by the market to price in future rate trajectory expectations. I would argue that a funded instrument like a CD is a better product for that purpose as it also factors credit offtake expectations.

Do CDs provide additional information on banks?

RBI mandates listing of bank equity on stock exchanges to improve disclosures and governance. Having CDs widely traded in the market would achieve the same purpose. CDs of different banks will trade at varying levels and any abnormal changes in yield would provide early information to the regulator on any change in the bank’s internals. Offshore markets provide this information to a certain extent and having a vibrant domestic CD market can serve a much better indicator on market perception of banks.

Would retail CDs reduce volatility in CD market rates?

Currently, CDs are used for meeting funding requirement needs in excess of retail and bulk deposit inflows. Increase in volume of retail CDs will reduce reliance on bulk deposits and wholesale CDs, thereby reducing volatility in market yield movements of CD rates and bulk deposits. Retail CDs would improve the stability of the liability franchise of banks.

Do CDs need to be a money market product?

Since banks are permitted to raise deposits of tenor longer than one year, they should also be allowed to issue CDs with maturity above one year. There is no plausible reason for restricting the tenor of CDs other than to force fit it into the regulatory turf definitions currently in place. The deposit guarantee up to 5 lakh should be available to CD holders, as is currently the practice.

Are retail CDs cost beneficial for banks?

It will be. Depositors can channel some of their investments in short term mutual funds into such CDs and the amount of money raised through them will increase. Cost of funds of banks will, therefore, reduce and the liability franchise will be more stable. They would be offering buyback on CDs at same terms as they offer premature withdrawals thereby incurring no incremental costs. Moreover, market will offer better rates for exit than premature withdrawal resulting that buybacks will be used mainly as a backstop facility under exceptional situations.

Would NIM volatility of banks reduce?

It will. Currently only lending rates move synchronously with policy rates. With retail CDs, deposit rates also would respond in a similar manner reducing leads and lags in borrowing and lending rates. This should reduce NIM volatility for banks and make it more predictable. This would also help analysts understand the business model and other aspects of the bank better.

Are retail CDs the same as deposits for a customer holding it till maturity?

It certainly is. There would be no difference for an individual holding a CD and a bank deposit, if held to maturity. The CD would be credited in the demat account of the individual, who has the added benefit of selling it when he needs liquidity. For depositors who want regular income, banks can think of instruments that can give them such income.

Would customers benefit from the premature withdrawals from CDs?

They would almost always benefit. For example, if a customer purchases a one-year CD and wants liquidity after six months, the market would surely give him a better price since the residual maturity is only six months. Even if it is not the case, the buybank facility of the bank would ensure he gets the same amount as premature withdrawal.

Is the retail CD market good for development of corporate bond markets?

It surely is. This is a product with maximum retail participation. Converting a depositor to a CD holder can dramatically improve the liquidity in non-SLR markets. There would be increased participation from Corporate Treasuries, intermediaries, and aggregators and this would help increase liquidity manifold for the benefit of individual investors.

Are multiple issuances of CDs cumbersome and difficult?

Banks surely need to put in place infrastructure and processes to make this happen. However, NBFCs who are regular issuers have shown the way in this regard. Banks can issue 1 month, 3-month, 6 month and 1 year CDs every month with particular ISINs at the start of every month. Through the month, they can keep reissuing the CDs with the same ISINs to depositors. At the start of the next new month, a fresh tranche of CDs with different ISINs can be issued.

As we can see from the above, a small step in regulation can create innumerable benefits to all stakeholders. Why delay a product whose time has come? Let’s make it a reality.

Srinivasan Varadarajan is chairman, Union Bank of India.

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