You and I are really important to the country. Did you know that we are the human shields that protect the nation? Against bank failures, against financial exclusion, against insurance exclusion, and against starvation of insurance agents.
While working on the Swarup Committee Report a couple of years back, I had reason to go fairly deep into the arguments presented by many parts of the retail financial market—the product people, the sellers, the regulators, the government itself. It was then that I realized the value of each one of us who finally has to pay for badly constructed financial products, skewed markets, one-sided contracts and regulatory gaps. If we were not going to buy the cost-heavy life insurance policy, for instance, how would India’s insurance penetration rise? The meat on the bone left for the industry and the sellers was meant to encourage penetration. Of course, we won’t go into why, after 50 years of meaty bones, the penetration is still nearer zero than 100. If we were not going to pay the obese commissions, how would lakhs of agents run their homes? If we were going to protest mis-sold products by our bank that never sleeps, some poor relationship manager was, gasp, going to see his career run aground. He would carry a lighter bonus sack home. Oh! My! God! (Yeah, I’ve been watching Friends on the 3G stick.)
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I see the same invocation in national interest to bring you and me on as human shields to protect bank profits. It took the Reserve Bank of India (RBI) 10 years of debate and discussion to change a shockingly titled formula. Money in a savings deposit earned interest on the minimum balance in a month. That meant that if, even for a day, your bank saving deposit balance fell to zero, you got no interest, even if your average balance was a few lakhs. It was as recently as 1 April 2010 that the formula changed to one that takes the average balance into account. Despite the debate beginning a full decade earlier, it took the regulator 10 years to change it? The reason for the delay, it would appear, was the reluctance of the banks to do it. Their arguments included: We are not prepared. Our technology platform can’t handle it. And finally, our profits will suffer. What’s left unsaid in the last statement is a threat to the regulator: if you push us too much we’ll go right ahead and fail, and then where are you going to be? How well this if-you-don’t-let-me-make-easy-profits-I-will-fail blackmail works we can see yet again. On Tuesday, RBI hiked the savings deposit rate by 50 basis points to 4%, but has not gone all the way to free up the last tethered rate in the system.
The debate about making the savings rate market-linked began in 2003 when the 3.5% rate was fixed. Over the years, rates on the lending side have slowly been dismantled so that we have a story where banking is a business with guaranteed profits. A bank has to be really sloppy (and some get there!) not to make money. Their raw material cost is mostly controlled by keeping the savings deposit rate fixed at a level that has given negative real return since 2003. The sale price of their product, money, or the lending rate, meanwhile, has been market-linked. The spread in the middle is cost plus profit, giving net margins in the band of around 1% to just over 6% and an average return on equity of 15-20% (data from Fitch Ratings 2011 Outlook: Indian Banks). Though the bulk of the banks are at the 3% net margin level, a few banks have done better, proving that efficiency can be generated through technology and processes. Getting the savings deposit rate market linked may just be the push that banks need to use technology and systems to improve profitability.
What does RBI fear? First, unhealthy competition. Since banks with a higher part of their raw material coming from Casa (current account savings accounts) show lower cost, any move to deregulate could raise costs goes the argument. And if the cost of funds rises, profitability will go down. My question to RBI: why are you so worried about the profitability argument of banks? Isn’t this a veiled bank failure threat? Two, it could create asset liability mismatch for banks. What RBI should say is simply this: deal with it. It is your core business to match assets and liabilities and not have the regulator hold down input costs for you. Three, it will lead to financial exclusion. Wow. Really? After more than 60 years of controlled rates more than half Indians are “excluded” or do not have a bank account. The metro-skew of bank accounts shows that holding the savings rate down will not nudge banks towards opening more poor or rural accounts.
RBI must remember that all the safeguards in place did not prevent some Indian banks from coming to the brink in 2008 due to playing hard and fast in the global securitised products market. To keep the retail depositor paying is just bad policy.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and can be reached at email@example.com