Banks are not keen to sell floating rate deposits

Bank of India the state-owned bank is offering 0.25% extra interest on long-term deposits. The depositors who are willing to put money in the bank’s floating rate deposits can avail this offer. The bank will reset the rate of such deposits, in the beginning of each quarter, linked to the bank’s term deposits.

Bank of India is one among the few commercial banks who are offering floating deposits but not all of them are offering term deposit rates as a benchmark for such deposits. Some banks are using profits on government securities, mainly 10-year bonds and 364-day Treasury bill, as the benchmark rates for such deposits.

The floating rate goes up with rise in interest rate therefore there aren’t too many takers of such deposits. On the other hand the banks are also not selling the product aggressively.

Banks are not garnering such deposits because they will have to pay higher interest rates in the future if the benchmark rate goes up. The depositors too are not excited about this product, as are for term deposits, because floating deposits has a freeze and if the depositors want to redeem the deposits before maturity, they will have to pay penalty by way of a sharp reduction in returns. In addition to this there is uncertainty of return on such deposits if there is any change in floating deposit rates.

“The product is yet to pick up in India. Retail depositors want a clear idea of what they are getting when their deposits mature. Floating rate deposits do not give that certainty,” said B. Sambamurthy, chairman and managing director of Corporation Bank.

The Reserve Bank of India, or RBI, have given the approval for offering floating rate on deposits six years ago, in 2002, when some banks and financial institutions started redeeming deep-discount bonds which were floated in mid-1990s when interest rates have gone up.

The long-tenure bonds had a maturity period between 15 and 21 years, on it the bank offered 14-15% interest rates to consumers. To these bonds “call” and “put” options were attached which allowed both bond holders and lenders to redeem the bonds at regular intervals. At that time the “call” option was used in the beginning of the century by most of the lenders when the interest rates had dropped sharply, in order to cut the cost of deposits.

After going through this experience, banks are not ready to lock themselves in for long-term deposits therefore there very few banks offering fixed deposits beyond three years.

While the banking regulator wanted to solve the problem by giving the banks right to offer floating deposits and also by giving them flexibility for fixing the cost of such deposits. According to bankers, who do not wish to be named, the aim behind introducing the floating deposit rates was to protect banks from long-term high-cost liabilities rather than giving customers a new instrument.

Moreover, even the customers have shown interest in this product even though it is mentioned in most banks’ product portfolio.

“The timing of the product launch was wrong. It got a beating that time and is yet to recover,” said a senior public sector banker who does not wish to be named. In mid-2002, the profit on benchmark 10-year paper was revolving around 7.65% but by the year end it closed at 6.08%. In October 2003 it further dropped below 5%. When the viewpoint on interest rates is clear, people do not wish to go for floating deposits.

Although in a rising interest rate conditions floating rate deposits seems to be attractive but the profits on the 10-year government paper may be anything but it is stable. In the beginning of the calendar year 2008 the profit on the benchmark 10-year paper, was 7.76% which has now dropped to 9% and had touched 9.5% in July.

“The floating rate deposit scheme did not evoke much response as expected because customers want certainty of a steady cash flow,” said an official of India’s oldest mortgage lender, Housing Development Finance Corp. Ltd, one among the few institutions that launched a floating rate deposit scheme in early 2004. “A steady cash flow is the key reason why people go for fixed deposits.”

Some of the banks have introduced flexi-deposit rate schemes so that floating deposit rates look attractive. For instance Exim Bank of India is offering a deposit scheme under which customers will get the benefit of rising interest rates, but will not get affected when the rates come down. This year, three-year and five-year floating deposits have been launched which are benchmarked to give profits in comparison to maturity government bonds.

“Traditionally, consumers want to crystallize income into a steady cash flow and generally won’t like to take risk of a floating rate system.” said Shankarnarayan R. Rao, executive director of Exim Bank.

“We welcome this product as it gives a better hedge and helps us tackle asset-liability mismatches. But for a customer, who wants to bet on uncertainties, investment in equities is a more attractive option,” said a general manager with a large public sector bank who does not wish to be named.

However banks are quite hostile while selling floating rate loans. On more than 70% of home loans banks have given floating rate loans and interest rates changes with the change in their benchmark lending rate.