The proposal to free up your savings bank account rate may have a mixed impact on your finances. While it may mean more earnings on your deposits in the savings bank account, it may also mean higher interest rates on banks loans and high transaction charges.
As of now, the savings bank deposit rate is controlled by the Reserve Bank of India (RBI) and is pegged at 3.5% per annum for all banks. The rate has remained unchanged since 1 March 2003. However, ever since the proposal has been in the pipeline.
In fact, this is the third attempt to deregulate the rate; the first being in 2002-03 and the second in 2006-07. Last time around, in 2006-07, the credit policy noted its significance, stating: “In principle, deregulation of interest rates is essential for product innovation and price discovery in the long run.”
Four financial years later, on 28 April, RBI once again took up the issue by releasing a discussion paper on deregulation of interest rates on savings accounts. The paper discusses the pros and cons that such a move can entail.
Will savings rates go up
Though RBI has given until 20 May to the public to comment, savings account rates may go up in the interim. “The apex bank may revise rates of savings bank deposits to 4-4.5% per annum in the upcoming monetary policy review (3 May),” said a banker, who did not wish to be named.
When asked about the possibility of such a move, Pratip Chaudhuri, chairman, State Bank of India, said, “The upward revision of savings deposit rates has been under consideration for sometime and they (RBI) may increase the same going forward.”
Will lending rates go up
Since the cost of funds for banks will go up, banks will try to make up for the same either by increasing the lending rates or by increasing transaction charges. Says H.S. Upendra Kamath, chairman and managing director, Vijaya Bank, “Post deregulation, the transaction cost will go up and to sustain our margins, we will have to either increase the lending rates and may be forced to increase charges on several counts, including minimum quarterly balance and charges for issuance of cheques, among others.”
However, some others maintain that cost of funds will not get affected. “Close to Rs 9 trillion is being held by the public in form of cash. If the interest on savings deposits becomes a bit attractive, a substantial part will make its way in the banking system. As a result, the liquidity in banking system will improve and that in turn will ensure that interest rate both deposit and lending do not harden much,” says Chaudhuri.
What’s good for you
Savings accounts constitute about 22% of total deposits of scheduled commercial banks and about 13% of financial savings of the household sector, says the RBI paper. So your savings sitting in the bank account will earn a little extra.
“Like many regulatory steps that have made our banking system as strong as it is and customer friendly, this step too will give small deposit holders get better interest rates as banks compete to price their savings appropriately,” said P.R. Somasundaram, managing director and chief executive officer, Lakshmi Vilas Bank Ltd.
What may benefit customers in real terms could be product innovation. If the experience of some countries are anything to go by, post-deregulation banks will launch new products, notes the RBI paper.
The central bank cites the case of post-regulation Hong Kong, where a number of banks launched products such as combined savings and checking accounts and introduced Hong Kong inter-bank offered rate-linked savings products. Another example that the RBI paper gives is that of “tiered structures of interest rates”. Tiered structures of interest payment basically means that as soon as the deposits hit a certain ceiling, the rates change.
You may earn a bit extra but it will be just that bit and may not drastically change your returns. Savings bank deposits have mostly yielded negative returns. Savings bank accounts pay 3.5% per annum that loses to inflation, around 8% as of now, really badly, while deregulation may fetch customers a higher rate, it is still unlikely that the returns would pace up with rising inflation.
It is possible that the number of bank transaction also get restricted to save on costs, says the RBI paper. For instance, in Hong Kong too, banks revised fees and charges and the minimum balance requirements after rates were deregularized.
A concern that RBI raises is increase in mis-selling. “It is also possible that banks introduce some complex products, which may not be so easily understood by savers. These strategies may result in increase in the mis-selling of savings bank products, which will also result in increase in the number of customer complaints,” according to the RBI paper.
Why banks aren’t happy
While the apex bank may be in favour of deregulation of savings deposits rates, bankers feel the time is not ripe for such a move.
“Before 1 March 2003, savings rates were 5.5% per annum. We would prefer a higher interest rate on savings bank deposit, somewhere between 3.5% and 5.5% rather than complete deregulation,” said Nagesh Pydah, chairman and managing director, Oriental Bank of Commerce.
Some experts predict unhealthy competition. “Besides increasing the cost of funds, it will lead to unhealthy competition among banks to corner a chunk of deposit,” said Chaudhuri. Huge outflows that such competition may cause can cause an asset-liability mismatch.
However, previous experience allays such fears. Banks did not witnessed any such competition when other deposits were deregulated. “For maturities of similar tenors, the deposit rates do not vary much among banks. The maximum difference is 100 basis points. Customers are unlikely to change banks for such small gains unless the service of the existing bank is very bad,” said chairman and managing director of a Mumbai-headquartered public sector bank, who did not want to be identified.