Saikat Das
moneycontrol.com
Floating rate interest on retail term deposits, while a popular product in the US and Europe, is mostly unheard of India.
State-owned
IDBI Bank on Wednesday launched such a scheme, which will be benchmarked to the average yield of 364-day treasury bill (T-bills or government security) auctions undertaken by RBI during the preceding three months. The interest would be reset every calendar quarter. In addition, there will be a mark-up of 100-140 basis points for different tenures ranging from 1 year to 10 years. It has a lock-in period of one year.
Here is how it works: Unlike the traditional fixed deposit schemes offering fixed rate of interest, these term deposits offer floating rates. Those are linked to a benchmark interest rate. For IDBI Bank, it is the average coupon rate of 364 days treasure bill auctions in preceding three months. Mark-up is the spread to be added to that average rate.
For example, if the average T-bill rate is 8.50%. IDBI Bank will add 1.40% (for 10 years tenure) to it and offer 9.90% p.a. to depositors. Now, if you deposit Rs 1 lakh, you will continue to get 9% for a tenure of 10 years under fixed rate scheme at IDBI Bank. However, in floating rate, it will keep changing in proportion with the T-bill rate every three months. If the average T-bill rate goes up to 8.60% in the next quarter, your rate will change to 10% p.a.
T-bill is a short-term investment option for banks and financial institutions with a sovereign guarantee. In addition to bonds, the government of India raises funds through this instrument for which investors are to bid for in a RBI auction.
T-bills are of three tenures: 91 days (about three months), 182 days (six months) and 364 days (a year almost).
A win-win for both banks and depositors This is a win-win situation for both the customers and banks. In a rising interest rate scenario, a depositor will benefit as T-Bill yields tend to go up resulting in a proportionate increase to the deposit rates. However, when interest rates drop, banks can protect their net interest margin through lower cost of deposits. Following a fall in T-Bill rates, deposit rates too will come down.
"Initially, it will be difficult to convince retail depositors about its benefits," R K Bansal, executive director, IDBI Bank told
moneycontrol.com.
"It will take time to promote this product. We will drive efforts to educate people about it. To begin with, we will start connecting senior citizens, high networth individuals (HNIs) and qualified professionals to promote it. This particularly suits for long term investors, who deposit sums without fearing interest rate fluctuations. In turn, we get long term funds to lend in longer term projects. Thereby, it helps fix the asset liability mismatch issue," he said.
Should you subscribe to it? "Actually, floating rate term deposits should be introduced when interest rates are rising. It helps attract depositors. We are definitely deliberating to introduce similar schemes. Currently our bulk deposit rates are way below the retail card rates. However, it will be a difficult task to convince retail depositors about it especially when interest rates have already peaked. But depositors can enjoy good rates over a period of time," said A D M Chavali, executive director,
Indian Overseas Bank.
Among various deposit maturities offered by banks, the tenure of 1-3 years are most popular. Depositors normally abhor the idea of locking their money in longer term FDs (5-7 years). A floating rate term deposit plan, according to bankers will certainly encourage investors to go for longer term deposits as you can always earn interest rates a few basis points higher than the government benchmark rates irrespective of any economic condition.
According to Ram Sangapure, general manager (retail), Central Bank of India, the bank's depositors may not be mature enough to understand floating rate term deposits right now. Due to peer pressure banks however, may gradually start introducing the same. The regulator seems to be keen on this.
"So far, we do not have any plan to introduce term deposits on floating rates. But we will take a look on it over a period of time. In developed nations, these schemes are benchmarked to the London Interbank Offered Rate (LIBOR). In India, it could be either T-Bills or Mumbai Inter-Bank Offer Rate (MIBOR) depending on individual bank," he said.
RBI stance on floating rate term deposit scheme The Reserve Bank of India advocated the cause of introducing floating rate based deposit plans to boost the sluggish deposit growth. Also, the central bank is in favour of bringing in suitable new investment concepts in India, which are very popular in developed markets.
In 2008-2009, a couple of banks had introduced such products but later withdrew them due to poor response. However, the largest housing finance company
HDFC had launched a monthly deposit plan in early 2010. It offered a floating rate of interest, which is benchmarked to the HDFC prime lending rate and would be reset at the beginning of each calendar quarter.
"For a common man, a deposit scheme based on floating rate is a hedging tool against the rising rate of inflation. Banks too can manage their cost of funds well. Interest rates cycles depend on a lot of factors. The product is a kind of shield against interest rate fluctuations," said Arvind Konar, head of fixed income, Almondz Global Securities.
Way back in early 1990s, the government had introduced capital indexed bonds as measure to mitigate the risk of inflation. But it was not a success. Moreover, the floating rate bonds are still there wherein banks can invest and get the benefit of not linking their investment on mark to market basis.
Can institutions too invest? Institutions like mutual funds, corporates and others too can invest here in the form of bulk deposits to get benefit of changing interest rate cycle. However, a lock-in period of one year can keep them away from it.
saikat.das@network18online.com 
