The Indian banks that have been successful in bringing down their cost of funds to some extent are resorting to the issuance of certificate of deposits (CDs) for raising short-term funds.

CDs carry higher returns as compared to the returns on any other money market instrument. The fund raising via this route has been primarily noticed among the public sector banks that were waiting for the cost of funds to decline before decreasing their lending rates. A bond dealer with a broking house said, "The retail deposit for one year carries at least 8.5 percent interest. Compared to this, it is cheaper for banks to raise funds through CDs."

Ever since the RBI has kept its key benchmark rates unchanged in its monetary policy review on January 27th, banks have started borrowing funds through short-term instruments. The Central Bank has discouraged commercial banks from parking funds with them and therefore has cut the reverse repo rate by 200 basis points to 4% since October 2008.

The other key policy rates such as cash reserve ratio (CRR) and repo rate have also been cut by 400 and 350 basis points to 5% and 5.5% respectively.Following these reductions, the state-run banks have reduced lending rates by up to 150 basis points and deposits rates by almost 300 basis points. On the other hand private banks cut the interest rates by around 50 basis points.

The economic conditions at the current phase are forcing banks to turn risk averse and this factor is attracting them towards alternative investment avenues. A senior SBI official said, "Risk aversion is forcing banks to look at alternative investment options, including commercial papers and CDs."

On Tuesday, State Bank of Mysore and State Bank of Travancore raised funds worth Rs 100 crore each through the issuances of CDs. The CDs are going to mature in six months times and will earn a return of 6.55% per annum. This move have is expected to influence several other banks that will also raise funds through the CD route.

CDs are fetching higher returns as compared to the 4% interest rate offered by RBI for parking money with it under the reverse repo window.

Not only have the bank resumed to borrow funds through the issuance of CDs, even the mutual funds offering fixed maturity plans are also keen in investing in such papers. They are shifting their preference in order to avoid the risk associated with the volatile market movements.

However bankers feel that the demand for these short-term papers has declined because the market regulator is asking for liquid funds to invest in CDs with tenure of up to 180 days.