Monday, November 21, 2011
Liquid Funds RIP??
(Had written this piece for Moneylife, which got published today. Interestingly, SBI has fired the first big canon, with an 8.5 percent return on a daily basis, for deposits over a crore of rupees) For corporates, it marks the end of having to put money in liquid funds. And of course, it screws up bank balance sheets, since in addition to high interest rates, these deposits will attract statutory liquidity demands) The RBI will now become like the dog that ‘did not bark’ in the Sherlock Holmes story. Thirteen back to back nudges and inflation is still strong. And we have the funny situation where a car loan is cheaper than a personal loan which is cheaper than a farm loan. It seems that the banks know that farm loans generally run the risk of remaining ‘outstanding’ for times to come. The RBI has done another dangerous move by freeing up the interest rates on Savings Bank Deposits. In an earlier argument against this, I had said that the RBI should have in fact made this zero. Now, RBI has ensured a rat race amongst the banks, to fight for the savings bank moneys. This is great for the individual who keeps his money with banks in savings banks. Unlike in the past, we must now ‘shop’ with banks for higher and higher rates. Yes, the RBI has said that for identical amounts, the banks cannot differentiate in the interest rate offered. That does not mean that we cannot get extra freebies from the bank. We should club our accounts together and use it as a bargaining tool. In case they refuse higher interest rates, we can always bargain for some other freebie. Now we will also have to be more combative and watchful with banks. They will try to make up for the higher interest rate by imposing a charge for virtually everything. Perhaps, this is where we should be alert. It could mean imposing charges for anything- from number of cheque leaves to imposing charge on a visit to the branch for anything. Perhaps, they will also start delaying clearing credits in order to enjoy a ‘free float’ on our money. While it looks good for the depositor, what about the investor? Not very good, I think. They will perhaps put up a brave front and say that they will hike their lending rates also. But, wait. Why would any blue chip corporate borrow at usurious rates? Maybe they can borrow elsewhere. This would force the banks to extend credit at high rates to riskier customers. Generally, when interest rates are high (both ways) the net spread a bank makes is higher than when interest rates are in single digits. So, initially, it would seem as though the banks would make higher profits. However, my call is that the banks will be in a rat race to mop up deposits and end up paying high costs for the same. Lending will deteriorate in quality as the banks will seek to deploy the high cost funds and earn a spread on it. I would generally keep away from bank stocks for some more time, till RBI gets its act together. A high portion of Savings Bank and Current account deposits (CASA as is popularly known) gives some banks an edge. For instance, SBI and HDFC Bank have CASA deposits of nearly 48% of total deposits. Now, the interest costs for these two banks will rise much higher than for banks which have a lower proportion of CASA. What will be interesting is to see what happens if and when the liquidity in the domestic markets ease out. Today, tight liquidity has pushed up short term borrowing and lending rates so high that there is not much gap between the interest rates on a thirty day loan as opposed to a ten year loan! Liquid funds give returns almost in line with yields on ten year government securities! Once liquidity eases, will the return on liquid funds crash? Logically, they should. Then we will have the funny situation of savings bank returns beating liquid fund returns! And with banks being forced to pay interest on ‘daily’ balances, the savings banks should replace the liquid funds, for the individual investor. We need not go to liquid funds at all. It saves us the bother of filling forms for purchase and redemptions. Now, interest rates are going to play an important role in all financial advice. We are perhaps entering a phase where fixed returns are going to be more tempting than equity returns, as companies struggle to grow in the face of weak capital markets, flagging demand and high resources costs, combined with run-away wage costs. The RBI has set in motion a run up in interest rates that will benefit the saver in the short term. I only hope that the lending rates do not go so high that it kills borrowing and borrowers. For the PSU Banks, given their stupid system of evaluating themselves based on the size of deposits, the RBI has put them in to ‘interesting’ times. R. Balakrishnan October 26th, 2011 link to the moneylife article http://moneylife.in/article/regulations-high-cost-of-higher-interest/21578.html