Sometimes we are not really sure of the money which we have saved with our sweat and blood once it is already in the hands of our partners in investments, I am specifically referring to the bank system which seems unpredictable in one way or another. There is indeed one thing that we must be very careful of, namely, that we trust our banks which are practically in-charged of our hard-earned money. These banks may make or break us indeed. A few days ago, the Reserve Bank of India (RBI) announced the credit policy. Most of what is said seems like Greek and Latin, and we quickly scan the newsprint to see whether deposit rates are going up, or interest on loans could come down; and when we see the opposite, we are, of course, disappointed. But the RBI uses the credit policy to signal what it wants banks to do. In the recent policy, repo rate — the rate at which RBI lends overnight to banks — was raised 0.25% or by 25 basis points to 5.75% pa, and the reverse repo rate — the rate at which RBI absorbs the surplus overnight funds from banks — was hiked by 50 basis points to 4.50% p.a. This is a total depressing moment indeed.
Overnight Funds with Banks
Now let us try to take a closer look with this fact in view of what’s happening with our banking system, as you freely deposit and withdraw money on a daily basis, your bank needs to ensure that it earns money on your deposits, especially as they now pay you interest too on a daily basis. If no other bank wants to borrow money in the inter-bank call money market, your bank will invest these funds with the RBI and earn 4.5% p.a. so I guess this makes the whole picture clearer.
Quite true enough, they will lend to another bank at a higher rate than that as, for the other bank, that would be cheaper than borrowing from the RBI at 5.75% pa (repo rate). The reason why the bank needs to borrow funds overnight is that they need to maintain a statutory liquidity ratio of 25% and a cash reserve ratio of 6% of the bank’s net demand and time liabilities. This is the usual flow of banking system in cases like this.
How does this impact you?
Well, let us see the consequences, the money that you have in your savings bank account earns you 3.5% pa at present. Since the interest rate corridor, or the difference between repo and reverse repo rate, has been reduced, inter-bank and short-term interest will move in a narrow band between 4.5% and 5.75% pa, and these are returns that liquid plus funds could earn. By now, of course, you are well aware that mutual funds have a tax advantage over bank deposits for those in the higher tax bracket — 20% or upwards. So, do consider moving your idle funds in the bank to liquid plus funds, which normally carry no entry or exit load.
Longer term investments
Finally, it is very interesting to take note that, the mutual funds also offer investment opportunities in fixed income products for the longer term such as government securities and corporate bonds. While these instruments carry a fixed rate of interest or coupon, the market rate of these fluctuates virtually on a daily basis. As a result, values of these schemes can fall in the short term: this happens funnily when interest rates are rising. However, if I do buy a bond which will mature in, say, 3 years, and hold on till maturity, I can be oblivious of these daily price movements.
Best Reading:
Which is the most suitable for you: Index or Diversified Funds?
Ten Essential Reasons Why You Should Save Money
In conclusion, you must therefore be knowledgeable and familiar enough with all the inside and outside of making your money work for you and of course not to be blind with all the possible consequences once you have entrusted and risked the money in a particular investment company such as the bank. There is a great difference if you are more well-versed in view of how your money may work for you and not just be passive about the possibilities on how you can earn more from your capital.
