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Banks betting big on CDs in a rollover jam

14 Jun 2011 Evaluate

Banks’ funding of growth with short-term resources, such as high-cost certificates of deposits (CDs), is beginning to haunt with state-run Vijaya Bank becoming the first of probably many victims as Fitch Ratings cut its credit outlook to negative from stable. Negative outlook reflects Vijaya Bank’s stressed funding profile at end-March 2011 due to its increased dependence on wholesale funds, particularly CDs.

While the reliance reduced in FY10, it reversed in FY11 with loan to customer deposits, excluding CDs of 89% at end-March 2011. Vijaya Bank had 44% of bulk deposits on its books, which is considered high for banks that lend for corporates and individuals for 3-5 years. Woes of banks that rely on certificates of deposit may heighten in the coming months with the latest Reserve Bank of India ruling that they do not invest more than 10% of their net worth in liquid mutual funds, which were the main subscribers of bank CDs. Not all banks have high CDs. Many banks, eager to grow in the last two years with high profitability, compromised on their asset-liability proportions by going for cheaper short-term loans, to lend for longer tenor that fetched higher yields. Since RBI started raising interest rates to curb inflation, short-term interest rates are rising, crimping profitability as banks cannot increase lending rates immediately.

This issue is peculiar to banks which are growing beyond their retail franchise. Banks’ exposure to mutual funds may fall by October 2011. This, in turn, will deter mutual funds from investing in bank CDs when they come for renewals. Further, it is estimated that nearly Rs. 40,000-45,000 crores is due for redemption by mid-June itself.
Axis Bank, Punjab National Bank, Canara Bank and Central Bank of India are some of the banks which have used the CD instrument to raise funds in the past. Others such as State Bank of India, Bank of Baroda and Bank of India don’t sell CDs often. Fitch in its rating on Vijaya Bank has said high institutional funding could significantly impact its net interest margins (NIMs) in the present rising interest rate scenario. If the bank continues to depend on wholesale funds, particularly CDs, its national long-term rating may be downgraded by a notch to ‘AA-(ind)’ to reflect the risk of greater return asset (ROA) volatility.

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Banks betting big on CDs in a rollover jam

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