The equity markets celebrated the Reserve Bank of India’s (RBI) statement that further rate hikes may not be necessary. That was seen from the jump in most sectoral indices, with banking being the only major sector playing spoilsport.
Banks, too, would have rejoiced at the broad RBI hint that it has reached the peak of its tightening cycle, if interest rates on savings bank accounts had not been deregulated. In fact, banks in which savings deposits form a small proportion of total deposits did very well. Look at Yes Bank Ltd, where current and savings accounts (Casa) deposits account for just 11% of the bank’s total deposits; its stock rose 8.8% on Tuesday. Or take Kotak Mahindra Bank Ltd, also with a low Casa, its stock moved up sharply as well. At the other extreme, State Bank of India, whose savings deposits accounted for 36% of its total deposits at the end of June, saw its stock fall 3.5%. HDFC Bank Ltd was also affected, as savings deposits account for 29.9% of its total deposits. Banks with a high proportion of savings deposits were hurt as they will bear the brunt of any increase in interest rates on savings accounts.
The deregulation of savings bank interest rates spells the demise of Casa as a measure of a bank’s ability to keep its cost of funds low. As Hemindra Hazari, head of equity research at Nirmal Bang Institutional Equities, points out, Casa can be window-dressed, unlike the cost of funds, which will now be the metric analysts will track. The premium that banks with a high Casa attracted will diminish.
By how much will interest rates on savings deposits rise? Well, the interest rate on term deposits of 7-90 days is around 7%. So the interest on savings deposits could settle anywhere between 4% and 7%. Banks are eager to have a large proportion of savings deposits because it usually denotes a long-term relationship. But with a low incremental credit-deposit ratio and low credit growth, banks may not be over-eager to attract deposits, which should limit any rate wars. Also, the economic slowdown is not a conducive environment for passing on any rise in interest costs, although that is clearly RBI’s intention.
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It is possible that banks may experiment with different types of savings accounts, as in the US—the ones with the most restrictions on withdrawals could attract a higher rate, while the ones that are almost like current accounts could get a lower rate.
What are we to make of RBI’s suggestion that the interest rate cycle has peaked? The problem is RBI has been systematically under-predicting inflation since 2010-11. In its second quarter review of monetary policy in early August, it published a chart that showed inflation would start to decline sharply from September. It now says the inflation rate will begin falling from December and will be 7% by the end of March 2012. The markets will hope and pray the central bank has got it right this time.
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Graphic by Sandeep Bhatnagar/Mint