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Banks in India may have to fight harder for deposits

Banks in India may have to fight harder for deposits
On November 12, the Reserve Bank of India (RBI) opened up a portal through which small investors can directly buy government bonds. Since then, the Nifty Bank, the index of banking stocks, on the National Stock Exchange (NSE) has lost nearly 7% of its value.

One could argue that a larger sell-off in Indian stocks is at play but banks have been the worst hit among all sectoral indices. Three straight weekly declines in the stocks of some of the country’s biggest lenders ⁠has led to huge wealth erosion. Private banking giants like ICICI Bank, HDFC Bank and the government-owned State Bank of India (SBI) are some of the most common names in mutual fund portfolios.

Aside from the compulsions of the traders who rely on signals on the charts alone, there are some fundamental fears at play too.

As it stands today, retail investors can get better long-term returns as well as a wider protection by directly investing in government bonds compared to fixed deposits at banks.

Bank deposits are insured by the government up to an amount of ₹5 lakh whereas the entire amount invested in government bonds are guaranteed by the sovereign. And, the returns are relatively exciting too.

The returns on some small savings schemes ⁠— some of the long-term ones even offer tax incentives ⁠— offered by the government had already outpaced bank rates. The retail direct platform selling government bonds will only add to the existing pressure.

Investment product
Interest rates
Fixed deposits with banks (Returns depend on lender and tenure. Senior citizens get higher rates)
2.5% to 6.2%

Longer the tenure, better the returns. But, interest is fully taxable. Deposits insured up to ₹5 lakh.
Small savings schemes from the government

6.6% to 7.4%

If the investment is unsold for over 3 years, the gains are eligible for indexation as well as a lower tax rate.
Long-term government savings schemes like public provident fund
7.6% to 8.5%

These investments can be used to claim tax rebates as well.
Benchmark bond yield (tenure 10 years)

6% - 7.1%

Fully taxable. They come with sovereign guarantee. Direct investments, unlike going via debt funds, can reduce expense ratios.

No wonder, reports suggest that big ticket investors like non-resident Indians are getting wooed by the latest option of directly investing in government securities, which come with higher returns (compared to other fixed income products), a certainty in cash flow and without costs and commissions, and sovereign guarantee for the entire capital.

The process may be a bit cumbersome for those without adequate patience for the infamous interfaces of India’s government websites. If the banks have to compete for deposits, the cost of funds will rise and eat into the profit margin.

But that’s not the entire story

For India’s banks, credit growth has improved but it is still far from the desired pace. Large corporations have still not ramped up investments and, therefore, borrowings have been tepid. This caps the lender’s ability to increase lending rates to cover the cost.

Bank loans to industry at the end of September were lesser compared to six months earlier, according to RBI data. Most of India’s large companies and conglomerates are still in the process of repaying old loans and strengthening their balance sheets.

Meanwhile, the growth in deposits moderated marginally to 10.1% in the 12 months to September, compared to 11% a year ago.

These are a few points to consider for individual investors, including non-resident Indians, who are considering direct investments into India’s government bonds:

Not all government securities are liquid. According to market watchers, only about 15 out of the 90 bonds available in the market are traded actively.

The market is, currently, dominated by banks and institutional investors. Buying directly will be far easier than selling (before maturity) for smaller lots.

After three years of holding, the return on investment in government securities via debt mutual funds is eligible for indexation (adjusting the cost to include impact of inflation) benefit while calculating capital gains. Direct investments are not eligible for the same. However, debt funds come with expenses which direct investments are free of.

The money invested in these bonds now may lose its sheen once the interest rates start rising. Analysts at Goldman Sachs expect RBI to hike interest rates by 75 basis points in 2022. However, for now, there is enough headroom before the bank rates come at par with the bond yields.

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