For SBI, gain is too little, risk too much
State Bank of India chairman Pratip Choudhuri now wants the minimum tenure for bank fixed deposits reduced from the existing seven days to three days. He also wants to pay interest (2%) on current account deposits, meant to facilitate transactions, not savings. This, he argues, will enable banks to compete with liquid/money market schemes of mutual funds for surplus cash held by corporates. To the extent such moves would directly access the funds that otherwise would be routed to the money market, from where the bank would have to access it at a higher cost. So, from the point of view of lowering costs, the move would appear to make sense.
However, Choudhuri's case is flawed, apart from the fact that SBI could mobilise more deposits by offering higher rates on savings deposits. A character of banks that sets them apart from other financial sector players is that their deposits are withdrawable on demand in a way that contributions to MFs, whether liquid or money market, are not. This is equally true of fixed deposits, though here, banks may levy a penalty for premature withdrawal.
So, while banks take short-term money for the purpose of lending, they must always be able to pay back deposits on demand. Any bank that is unable to pay its depositors as and when they demand their money back risks a run on the bank. This would hurt the entire banking system. Corporate deposits, given their size (typically large), could be potentially far more destabilising than retail deposits. This is why most countries try to discourage excessive reliance on short-term deposits and prohibit banks from paying interest on demand deposits, including deposits with original maturity of less than seven days. With net interest margins at a fabulous 3%, why should Indian banks run such a risk?