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Deregulation of Savings Bank Interest Rates  Boon or Bane?

 

by

NSN REDDY*

Email id: nsn6507@yahoo.com ;       Mobile 09490213002

 

 

Banks are playing a catalyst role in economic development by mobilizing resources from the public and deploying the same to the needy segments to achieve the desired GDP growth rate, besides enhancing the value of all the stake-holders.

 

 For mobilization of resources - traditionally, banks are offering standard products such as Current, Savings and Term Deposits to suit the financial needs of the depositors. Out of the said three products, term deposit product has been attracting the attention of majority of the customers across the banks. It is evident from the fact that the share of term deposits to total deposits is hovering around 61% to 66% in the last one decade. Next to term deposits, the most preferred product is Savings Bank accounts followed by Current Accounts.

 

 Current accounts are primarily meant for companies, public enterprises and business firms having numerous banking transactions daily. On the other hand, Savings accounts are the most common operating account for individuals and others for non-commercial transactions. At present, banks pay no interest on Current accounts and regulated interest @3.50% p.a. on Savings accounts.

 

 Current and Savings (CASA) deposits have attained utmost importance in the post reform period as these deposits are stable and significantly influence the cost of deposits, which in turn has a direct bearing on the Net Interest Margin (NIM) and Profitability of the banks.

 

 Despite focused attention by the banks on low cost deposits, the share of CASA has been coming down in the recent years, which warrants the attention of the Banks and the Regulator.

 

Bank Group-wise Percentage Share of CASA Deposits in Total Deposits

 

Bank Group

2006

2007

2008

2009

SBI & Associates

43.40

42.90

42.00

38.60

Nationalized Banks

38.20

35.40

33.00

29.90

Private Banks

30.40

29.80

32.80

32.90

Foreign Banks

50.50

45.10

44.70

41.70

All SCBs

38.60

36.60

35.70

33.20

  (Source: RBI Report on Trend and Progress of Banking in India 2008-09)

 

 

Observations:

  The share of CASA is high in Foreign Banks followed by SBI & Associates, Nationalized Banks and Private Sector Banks.

   Despite best efforts by the Banks, consistent decline in the share of CASA is observed among all categories except Private Sector Banks during the last four years.

   The increase of term deposits over a period of time is mainly on account of flexible norms coupled with relatively higher interest rates on term deposits.

   Moderation in deposit growth is partly due to corporates withdrawing surplus funds parked in banks, as projects delayed during the slump period are now being restarted.

   Of late, household savings have started moving out of banks to more attractive options such as equities, gold and real estate. More money also seems to have moved into Government Small Savings Schemes such as the Public Provident Fund, which offers better post-tax returns. The negative returns on bank deposits seem to have led to a revolt from middle India, even as companies withdrew money from banks to fund new projects.

 

The deceleration of CASA deposits may pose a challenge for the banking sector since the revival of economic growth requires adequate credit flow at reasonable cost. This warrants the banks to initiate steps to improve the share of CASA deposits.

 

Savings Bank Deposits:

Savings Bank deposit is common and widely used instrument by a majority of the people irrespective of their economic status, across the country. It is an important component of a banks deposit base since the funds mobilized under this category is more stable and cost effective compared to Term Deposits. At present, SB deposits constitute 22% of total deposits of the banking industry.

 

Major share of SB accounts pertains to households, who are subjected to unfair treatment with regard to interest rate, which is evident from the fact that SB interest rate remains the same since 2003. The inactive approach of the Regulator acted as disincentive to the small savers, who are the backbone to the resource mobilization.

 

Normally, the depositor expects to be compensated for the time value of money as well as to cover the associated risks viz., Inflation, Systemic (default) and Regulatory Risks (tax payment). Inflation plays a vital role to arrive at the real interest rate as it has a direct bearing on the purchasing power of the depositor.

 

RBI has announced downward revision of SB Interest rates from 4.50% to 4.00% on 01.04.2000 and subsequently from 4.00% to 3.50% on 01.03.2003. Till 31st March 2010, although banks offered 3.50% interest on SB deposits, the effective rate works out to only 2.75% on account of the minimum balance stipulation clause i.e. interest is paid on the minimum balance between 10th and end of the month.

 

Though, banks are functioning in a deregulated environment, SB interest rate still continues to be regulated / administered by RBI. The present interest rate i.e. 3.50% is too low as it does not offset the prevailing inflation rate thereby causing the net return zero or some times negative.  

 

In absolute terms, the interest rate offered by banks in India on SB deposits is relatively high by 100 to 200 basis points compared to the interest rates offered by other countries on similar products, but in reality, the Real Interest Rate works out to be much lower in India on account of inflation or other external effects.  For example - Banks offer SB interest at 3.50% where as the current inflation rate is 5.50%, thereby causing the real return on SB deposits to be negative.

 

It is quite unfair that majority of bank depositors are meeting with raw deal and not protected from unreasonably soaring inflation. With improving financial literacy and further penetration of capital market activity, banks are likely to lose this stable source of funds unless they treat depositors fairly.

 

The growth model i.e. market-driven being adopted, has exposed the aam aadmi to market forces in almost every sphere of life and there is no justification for clinging to regulated interest rates on SB accounts. Surprisingly, there is no change in SB interest rates since March 2003 despite sea changes in the banking space.

 

Thanks to Ms.Kishori J Udeshi, former Chairperson, Banking Codes and Standards Board of India (BCSBI) who raised two pertinent issues viz., Method of computation of Interest and Quantum of interest on Savings Bank Deposits, in the year 2007 and brought the same to the notice of Regulator / Government for debate/deliberations. Now the ball is rolling and recently RBI initiated steps in this direction. Hope the dream comes true shortly.

 

Recent changes:

RBI abolished the system of calculating interest due on Savings accounts based on the minimum balance in the account between the 10th and 30th of the month w.e.f 01.04.2010. Now, interest is being calculated on the daily balance and with this the cost of the deposit of the banks is expected to move up by at least 75 basis points. Though this move helps the SB depositors to earn more interest on their balances, the interest rate is still low compared to the market rates since the SB interest rate is still under the control of RBI.

Anticipated changes:

Sri.D.Subba Rao, Governor, RBI has indicated recently that Central Bank is in favor of deregulating the SB interest rate thereby allowing banks the freedom to fix their interest rates on Saving Bank deposits. This would be a step in the direction of attaining the objective of Financial Sector reforms and would have an impact on the Banks and Account holders, as enumerated here under:

Impact on Banks:

  Increased competition among banks might lead to an increase in the SB interest rate which would definitely have a bearing on cost of deposits, as SB interest rate is likely to go up by a minimum of 50 basis points.

 

  In the deregulated interest rate environment, interest rate on SB and term deposits would be inter-linked and any change in SB interest rate means fine tuning the Term Deposit interest rates too. Hence, the ALM desk of the banks needs to be alert on an ongoing basis.

 

  The additional cost works out to 27 basis points on account of the revised procedure in SB interest calculation i.e. on the daily products and the likely hike of a minimum of 50 basis points in the ensuing period. This is going to have an adverse impact on the NIM of Banks if it will not be accompanied by a corresponding increase in lending rates.

 

  Deregulated SB rates will obviously be linked to the liquidity situation. So there is a possibility that banks may tweak the rates in tune with changing circumstances. This may lead to reduction of interest rate in the long run.

 

  Mis-selling might increase which would result in more number of complaints to the Banks Customer Care department as well as to RBI and BSCBI.  This may prompt RBI to intervene and regulate the Service Fees attached to SB accounts.

 

  Enable the banks to achieve financial inclusion since SB deposits would be made more attractive to remote rural folk to save their hard earned money with banks.

Impact on Customers:

  Banks tend to offer additional interest which would help the retail customers, hitherto neglected. It also enables the High Net worth customers gain more.

 

  The likely increase in SB interest rate may lead to shift of short term deposits (below six months) to Savings Deposit as interest differential would be insignificant.

 

  To offset the additional interest cost, Banks might hike the Service charges attached to SB Products.

 

  In the deregulated environment, interest rates are not fixed anymore and hence there is also a possibility of downward revision of SB interest rate by Banks in the long run, which would be detrimental to the interests of small savers.

 

  At present, transactions through the Electronic Payments channel are on an increase and the Account number of the depositor is updated at many locations to receive funds through ECS/NEFT/RTGS. Frequent closure and opening of SB accounts would impact the e-Payments channel.

  

Once the SB interest rates are left to market forces, it tends to intensify the competition in the banking space. Banks with low SB base will find this an excellent opportunity to build their Savings Bank portfolio by offering attractive rate of interest in comparison with other banks. This may cause some movement in SB accounts among the banks. However, there is another school of thought that it may not impact much on deposit flight since normally depositors may not be inclined to shift their accounts from one bank to another on account of paltry interest differential.

While there may certainly be an increase in SB interest rate, the differential may, however, be under check since it is linked with Repo Rate and Call Money Market Rate. At present, banks are borrowing funds from RBI at Repo Rate i.e. 5.75% and hence it is unlikely that the SB interest rate moves beyond the Repo Rate.

The issue of deregulation of SB interest rate is yet to be debated and RBI still has to take a call on whether to free it completely or regulate it beyond thresholds. In order to protect the small depositors issue, there is a need to have a minimum interest rate prescription lest some banks may tend to lower the interest rate below the present rate i.e. 3.50% which would jeopardize the interest of small account holders who are large in number.

RBI is yet to address another important issue pertaining to Savings Bank Deposits i.e. Interest application frequency, in the light of the fact that banks are levying interest on loans/advances accounts at monthly intervals where as paying interest on SB balances on a half-yearly basis, thereby depriving the benefit of compound interest to SB depositors.

The proposed move is good news to small savers, retired people and middle-class households since they may earn reasonable interest more or less equal to short term deposit interest rate (6 months), to protect their investments from inflation. Banks are required to undertake realignment of their deposit mix, along with necessary changes in term deposit interest rates, besides aligning interest on loans and advances so as to keep their NIM intact in the changed scenario.

Nevertheless, it is to be seen how effectively and efficiently Banks handle the delicate issue duly protecting the interest of depositors as well as borrowers. It is a walk on a tight rope and a challenge to the Banks!

Let us wait and watch.

***

 

***September,  2010***

*[Mr NSN Reddy, who is working as Chief Manager, in Andhra Bank has B,Com, CAIIB, PGDBM (NIBM) qualifications to his credit and has over 32 years of Banking experience]

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