Few bankers are excited about the impending deregulation of savings deposit interest rates, one of the last bastions of administered rates in Indian banking. Non-resident Indian deposits is the only other banking product that offers mandated rates. Banks fear that once the savings bank rate is deregulated, competition will force them to raise the rate and that will affect their net interest margin (NIM), or the difference between the cost of funds and earnings on the deployment of funds, which is key to their profitability.
The savings account rate, last changed in March 2003, is currently pegged at 3.5%. Until the fiscal that ended in March 2010, the average cost of banks for such accounts was much lower—at around 2.8%—because they used to pay interest only on the minimum balance kept between the 10th and the end of a month. From April they have been paying interest rate on a daily average basis.
A savings account is the most common operating account for individuals and others for non-commercial transactions—a hybrid of current account and term deposit account, providing the convenience of easy withdrawals, writing of cheques and an avenue to park short-term funds that earns interest. Banks generally put a ceiling on the total number of withdrawals permitted and stipulate a certain minimum balance to be maintained in such accounts.
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In the 10 years between 1998 and 2008, the composition of savings accounts had not changed and the household sector continued to have a share of about 85% of such deposits despite a reduction of interest rates. This essentially means that, even though the average inflation rate is higher and the real return from savings accounts is negative, Indian households continue to keep money in such accounts for the sake of convenience. This helps banks lower their average cost of money and maintain a healthy NIM. Which is why the focus of all banks is to push up the proportion of current and savings accounts in their overall deposit portfolios. Banks do not pay any interest on current accounts.
The Reserve Bank of India (RBI) first seriously explored the option of deregulating the savings bank rate in 2006 but could not do so as the national bankers’ lobby, the Indian Banks’ Association, strongly opposed it, fearing an increase in the cost of funds. But RBI must push for it now as the banking regulator’s job is not protection of banks’ balance sheets alone; it needs to safeguard consumers’ interests too.
Deregulation of savings bank interest rates may trigger a rate war among banks. With this, volatility will increase as customers may choose to leave one bank and go to another to earn a little more on their money. Typically, about 95% of savings bank deposits is considered core deposits on which banks depend to build loan assets. So, volatility will make asset-liability management difficult for banks. But that’s the headache of the industry; why should bank customers suffer for it?
Once savings accounts rates are freed, banks will be forced to innovate. The number of transactions and the use of channels will determine the interest rates on such accounts. Currently, the cost per transaction in a bank branch is about Rs 50 and at an ATM about Rs 20. This comes down to Rs 10 when a customer goes for Internet banking and Rs 5 for mobile banking. In a deregulated regime, banks will encourage customers to increasingly use alternative channels to lower costs as once the cost of transactions declines, they will be able to offer higher interest rates. To be sure, deregulation needs to be done in phases. RBI can start by keeping the current rate—3.5%—as a floor and allowing banks to offer higher interest rates, if they choose so.
Death of the bank rate
After the mid-quarter review of monetary policy, RBI’s bank rate and repurchase, or repo, rate have converged. Both are now pegged at 6%. This is ridiculous as the bank rate is a forward-looking statement on RBI’s views on interest rates in the medium term while the repo rate at which the central bank infuses money in the system is a short-term signalling device.
By tradition, the bank rate is always at the top of the agenda of the committee of the central board of RBI that meets every Wednesday in Mumbai. The last time the bank rate was tinkered with was in April 2003, when it was brought down by 25 basis points to its three-decade low of 6%. One basis point is one-hundredth of a percentage point. Since then, the bank rate has not been touched even though the short-term repo rate and reverse repo rate (at which RBI drains liquidity) have been changed frequently. For instance, since October 2008, in the wake of the collapse of the US investment bank Lehman Brothers Holdings Inc. that plunged the world financial system into its worst credit crunch ever, the repo rate came down from 9% to 4.75% before rising to 6%.
Similarly, the reverse repo rate dropped from 7.5% to 3.25% before moving up to 5%. But the bank rate has been holding steady at 6%. Why? This is simply because it has lost its relevance.
Theoretically, the bank rate, also referred to as the discount rate, is the rate of interest which a central bank charges on its loans and advances to commercial banks and other financial intermediaries. Changes in the bank rate are often used by central banks to control money supply.
In India, RBI infuses short-term liquidity at the repo rate. The bank rate was earlier the refinance rate at which banks used to draw liquidity support from the central bank. However, the refinance window has been shut and for all practical purposes the bank rate is of no use. It’s high time RBI gave it a decent burial.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to firstname.lastname@example.org