The next big battle on the Indian banking turf will be fought for savings bank deposits. After freeing all loan rates, the Reserve Bank of India (RBI) plans to give banks the freedom to decide on the interest rate they offer customers for money kept in savings accounts. It can happen sooner than later and dramatically change the cost structure of deposits for banks and put pressure on their net interest margins (NIMs). That, in turn, will have a bearing on their valuations.
NIM, a key parameter to judge a bank’s operational efficiency, is loosely the margin between the yield on assets, or loans, and the cost of liabilities, or deposits. It will shrink when the cost of deposits goes up. Most bankers feel that if the savings bank rate is freed, there will be a rate war as banks compete fiercely with one another to mobilize savings deposits. Currently, the rate is fixed and hence there is no overt competition, although smarter banks always try to gather as much current and savings accounts (Casa) as possible to bring down their overall cost of deposits. Punjab National Bank and State Bank of India in the public sector and HDFC Bank Ltd, Axis Bank Ltd and ICICI Bank Ltd in the private sector have higher Casa than others.
Current accounts are opened by companies, public enterprises and entrepreneurs who perform many transactions daily. These accounts are cheque-operated and there is no restriction on the amount of money that a customer can deposit or withdraw any number of times. Banks do not pay any interest on such accounts and get the money free but they generally impose service charges for operating a current account. The customers are meant to keep a relatively higher minimum balance in such accounts as the balance they maintain tends to be volatile because of too many transactions.
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A savings account is the most common operating account for non-commercial transactions. Banks generally put a ceiling on the number of withdrawals and stipulate a certain minimum balance to be maintained in such accounts. The savings account rate is 3.5%, but until recently banks were actually paying less because they used to pay interest only on the lowest balance kept between the 10th and the end of a month. From this month, banks are required to calculate the payment of interest on the daily balance kept in a savings bank account, and this will push the cost of savings bank accounts by about 34 basis points, according to an RBI estimate. One basis point is one-hundredth of a percentage point.
No wonder that in February, much before the new norm came into effect, the Indian Banks’ Association (IBA), a national industry lobby, asked RBI to reduce the savings bank deposit rates to protect banks’ margins. It requested the central bank to either reduce the savings bank rate or postpone the implementation of the new method of calculating the savings bank rate. The suggestion was to cut the rate to 2.5%.
With the wholesale price-based inflation at 9.9%, consumers already earn a negative interest rate on their money kept in savings bank accounts and the rate should not be reduced.
To be sure, even though the savings bank rate is 3.5%, banks spend money to issue cheque books, to send quarterly statements to customers by post as well as on customers’ visits to bank branches. The cost of servicing a customer during one branch visit in a metro could be as much as Rs60, but this comes down if the customer uses automated teller machines (ATMs).
The logic behind the plan to free savings bank interest rate is not to create grounds for offering higher rates to consumers. There are, in fact, two compelling reasons to free the savings bank rate. First, an administered savings rate reduces RBI’s manoeuvrability in using interest rate signals as a monetary tool. When the Indian central bank was cutting policy rates and flooding the financial system with cheap money to fight the impact of global crisis in the wake of the collapse of US investment bank Lehman Brothers Holdings Inc., RBI found it difficult to bring down the policy rate below 3.5% as the administered savings rate was acting as a floor for all rates. Once the savings rate is freed, it will give more flexibility to RBI in its policy rate decisions. Second, after freeing all rates for assets (loans), the regulator cannot afford to have an administered rate for liabilities (deposits) as that will create a risk for the system in the long run as banks will face interest rate mismatches.
The Indian banking system’s deposit liability is Rs45 trillion, and roughly one-fourth of this is in savings accounts. The cost of money for banks will certainly go up as they will be willing to pay more too woo depositors, particularly in big cities where private and foreign banks are aggressively vying with public sector banks for deposits and loans. In October 2005, RBI first asked IBA to chalk out a road map for deregulation of savings bank accounts, but the bankers’ lobby had not shown any enthusiasm. RBI should not make any compromise on this as protecting consumer interest is more important than banks’ profits. And this is why the regulator should not limit banks’ freedom of fixing the savings bank rate by setting a cap of 3.5%. The rates should be totally free. That will encourage competition and creation of new liability products to benefit both the industry as well as consumers.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Please email comments to email@example.com