Wonder why Banks advertise Deposit rates for strange Term such as 390 days, 777 days, 888 days etc?
Guest post by
Bhuvaneswari Venkataraman, Lead Consultant - Banking and Capital Markets, Oracle Practice, Enterprise Solutions, Infosys Technologies Ltd.
Whether you are a top investment planner or adviser or even a common man unfamiliar with finance or Markets, you would invariably be seeking the term deposits rate of Banks which serves as a benchmark rate for many when they try to evaluate the different investment options. When you find the advertisement with odd terms such as 390 days, 678 days, 999 days you must be wondering what is the reason behind this specific tenure. Well answer lies in managing liquidity management to reduce overall risk. Let us see how liquidity management propels the interest rate and the tenure of a banking product.
Usually banks, lend for a longer period than for which they borrow leading to mismatched flow of funds inherent to a banking system. This gives rise to the potential inability of a bank to meet its payment obligations in a timely and cost effective manner. This is called liquidity Risk. It arises when the bank is unable to generate cash to cope with a decline in deposits/liabilities or increase in assets.
The Bank has to ascertain whether it will be able to meet maturing obligations on the date its financial instruments fall due. For this, they must prepare a maturity-profile of Assets and Liabilities along with the projected cash-flows over a series of points of time called time-buckets and estimate the probability of facing any liquidity crisis. The difference between cash inflows and outflows in each rung of this ladder , the excess or deficit of funds becomes a starting point for a measure of a bank's future liquidity. An increase in the mismatch over time could indicate that a bank has a potential funding problem. One of the avenue for mobilization of funds which is dependable (less volatile) is the Time Deposits and hence Banks tend to boost this avenue with attractive rates for terms for which they have a liquidity mismatch (require funds). Hence we see Fixed Deposit Product in market with higher interest rates for such strange terms such as 390 days etc to overcome such funding problem.
So how does bank arrive at such a decision.. They rely on systems which are capable of analyzing data on various parameters of liquidity to support their decisions and plan for future. Oracle Financial Services Asset Liability Management (OFSAA ALM) is one such system which helps Banks Plan, Measure and Manage liquidity risk. It aids the institution to examine all the assets and liabilities simultaneously on a continuous basis with a view to ensuring a proper balance between funds mobilization and their deployment with respect to their maturity-profiles, cost, yield, risk exposures, etc so as to avoid liquidity risk.
