The games banks play: will high deposit rates lure the NRI?

At a time when a weak rupee is spurring capital outflows from India (Indians abroad rather hold dollars now), banks which are desperate for capital have raised interest rates on fixed deposits held by non-resident Indians.The move will not only encourage NRI’s to remit dollars into India, but will also help stem the declining rupee.

This Friday, barely a week after Reserve Bank of India deregulated non-resident external (NRE) deposits, allowing banks to offer higher interest rates to dollar-denominated accounts, five Indian banks, including HDFC Bank and Yes Bank upped their interest rates on such deposits in order to lure foreign money.

The rupee has plummeted to record levels breaching the 54 mark against the US dollar recently. It is currently hovering between Rs52 and Rs53 to a dollar and has been badly hit as FIIs cash out of Indian equities to safer investment avenues such as US government bonds.

Since the cost of NRE deposits is lower than that of domestic deposits for a matching tenure, banks have opted for hiking rates on these accounts.

However, K Kanagasabapathy, director EPW Research Foundation, argues that even if NRIs are attracted by such higher returns,“given the higher cost of funds already faced by banks, besides the maturity and currency risks such deposits carry in their balance sheets, banks may not clamour for such deposits.” Moreover, since these deposits are more outside India, the entire credit risk is borne by the depositor and hence is a risky proposition (if banks here go bust, for the foreign bank through which Indians abroad deposit do not provide insurance).

Dhanlaxmi Bank, that has a strong presence in Kerala seems to care little about the flee that could happen if the rupee strengthens. The bank which attracts a substantial chunk ofremittancesand NRI deposits, was the first to raise rates. While the bank hiked interest rates on NRE deposits to 8% for a maturity of one to three years effective December, the rate for deposits for three years and up to 10 years will be 7.75%, the bank said in a release.

Similarly, another Kerala-based lender Lakshmi Vilas Bank revised the interest rates on NRE deposits of various slabs on Tuesday. For one year and under two years, it is offering 10%, 8% for deposits of two to three years and 7% for deposits above three years.

HDFC Bank increased the interest rates on NRE deposits of Rs 1 crore and above with a maturity of one to two year to 9% against 3.82% earlier. It has, however, left the NRO deposit rates unchanged.

Continuing its aggressive efforts to broaden its retail base, private lender Yes Bank today said it will raise interest rates on fixed deposits held by non-resident Indians (NRIs) to 9.6% from 3.82%.This is the second major attempt by Yes Bank in as many days to attract funds from the large number of Indians living abroad. The bank raised its savings account deposit rate by 200 basis points to 7% on Thursday. The higher rates, coupled with the dollar’s recent rise against the rupee, are sure to encourage foreign exchange inflows, Chief Executive Rana Kapoor said in a statement.

The state-run Allahabad Bank too announced a spike in its NRE deposits up to 7.5 percent. The Kolkata-based bank will now offer 7.5 percent for one to two years tenor (against 3.82% earlier), 7% on deposits of two to three years (from 3.51%), and 6.75% for those above three years (from 3.64%).

Given the volatility in the currency market, investors will be apprehensive in investing in Indian banks, though interest rates are higher, as the gains made by way of higher interest rates will be lost due to depreciation of the currency.

Further, for the banks, the cost of its deposits will shoot up substantially as NRE deposits were earlier costing lower than saving deposit rates. These have now been increased by nearly 2.5 times in most of the cases. The solution for bringing in dollars is also temporary as the money will be withdrawn once the deposit will mature. The banks are clearly counting on a stronger economy when the deposits mature.