CDs fetch higher returns than other money market instruments. Banks have begun raising short-term funds through issuances of certificate of deposits as the cost of funds has declined and the banking system remains wary of extending loans.

The aggressiveness in raising funds through CD issuances was witnessed primarily among the state-run banks, who were trying to reduce their cost of funds before lowering the lending rates. The retail deposit for one year carries at least 8.5 per cent interest.

Compared to this, it is cheaper for banks to raise funds through CDs, said a bond dealer with a  broking house.

Banks have resumed their borrowing of funds through short-term instruments after the Reserve Bank of India kept its key benchmark rates unchanged during the monetary policy review on January 27.

The central bank, however, indicated that the banks need to cut lending rates to pass on the benefit of the past cuts to the end users, or borrowers.

RBI has reduced the cash reserve ratio or the proportion of deposits set aside by banks by 400 basis points to 5 per cent, while the repo rate or the rate at which it lends to banks has been cut by 350 basis points to 5.5 per cent.

To discourage banks from parking funds, instead of lending, the reverse repo rate has been pared by 200 basis points to 4 per cent.

So far, public sector banks have reduced lending rates by up to 150 basis points, while private banks have lowered interest rates by around 50 basis points. However, deposit rates have fallen by as much as 300 basis points.

Accordingly, State Bank of India [Get Quote] last week cut home loan rates by as much as 425 basis points to 8 per cent for all new loans to be sanctioned before April 30.

State Bank of Mysore [Get Quote] and State Bank of Travancore [Get Quote] on Monday raised Rs 100 crore (Rs 1 billion) each worth of funds through issuances of CDs. The CDs, maturing in six months, were raised at 6.55 per cent per annum. Several other banks are also firming plans to raise funds through issuances of CDs, sources said.

Banks have slowed the sanctioning of fresh loans as the economic outlook continues to be grim. RBI has lowered the economic growth outlook by 0.5 per cent to 7 per cent for the year ending March 31, 2009.

Banking sector loans to customers have contracted by more than Rs 13,800 crore (Rs 138 billion) in the fortnight ended January 16, 2009 to Rs 26,45,150 crore (Rs 26,451.5 billion).

Overseas sales of domestic goods dipped for the third consecutive month in the backdrop of the global economic recession, data released by the commerce ministry showed.

Exports shrunk 1.1 per cent in December, 2008 to $12.69 billion as against a 21 per cent growth in the year-ago period.

Risk aversion is forcing banks to look at alternative investment options, including commercial papers and CDs, said a senior SBI official.

Banks investing in CDs fetch higher returns than that offered by RBI for parking money with it. Banks earn 4 per cent for lending overnight money to central bank at 4 per cent.

Apart from banks, mutual funds offering fixed maturity plans are also keen to invest in such papers as they prefer holding on to shorter maturity instruments to avoid the risk arising from volatile market movements.

Bankers said that with the market regulator asking liquid funds to invest in CDs with a tenure of up to 180 days, the demand for these short-term papers has dropped.

In a few months, the maximum tenure of papers in the portfolio of these funds has to drop to 90 days.