Keep using savings deposit for emergency funds

Keep using savings deposit for emergency funds

In the first such move in the last eight years, the Reserve Bank of India in its annual credit policy review on Tuesday revised interest rates on bank savings accounts by 50 basis points—the rates are up from the present 3.5% per annum to 4%. One basis point is one-hundredth of a percentage point.

The move comes close on the heels of RBI circulating a discussion paper on freeing up savings deposits rates and was as such expected by most experts. The interim measure to increase the rate is an indication of RBI’s firmness on deregulation. “It is too premature to conclude whether this is the first step towards deregulation of savings bank deposits or not. But certainly the apex bank has tried to realign interest rates with current market realities," says Arun Kaul, chairman and managing director, UCO Bank.

Also See Saving Statistics (PDF)

The interest rates on savings bank account are regulated at present and are determined by the central bank from time to time. The last time the rates were revised was on 1 March 2003.

How much is the benefit

Nearly 36% of the country’s population have savings bank accounts, according to the RBI paper. And all of them will now earn an additional 0.5% on their savings.

More earning is good, but it will not translate into a benefit for customers as such. Interest rates on bank savings deposits have mostly yielded negative returns in the past—taking inflation into account—and that is unlikely to change even now. With RBI projecting inflation to be around 6% for 2011-12, the new rate of 4% will also yield negative returns.

Likely impact

Higher fund flow: The move is likely to result in higher fund flow in bank savings accounts. At the end of March 2009, the total amount in savings bank deposits of all the banks put together stood at 8,96,301 crore, accounting for 22.1% of total bank deposits, the paper adds.

Lending rates may go up: “Due to a hike in savings rates, our margins will be impacted by 10-15 basis points and we have no option but to pass on the hike to customers," says S.C. Sinha, executive director, Oriental Bank of Commerce.

IDBI Bank Ltd has already hiked lending as well as deposit rates and other banks are expected to follow suit. “We have revised our base rate by 50 basis points to 10%. We have also decided to increase deposit rates by 25-50 basis points across various maturities. Both the rates will be effective from 5 May," said R.M. Malla, chairman and managing director, IDBI Bank Ltd.

How much should you keep in savings account

Given the fact that savings bank will give negative returns even after the hike, you need to be careful about parking your money in your savings account. In fact, planners suggest you should only keep contingency funds in the savings account.

“Despite the latest hike, it (bank savings account) would not be able to overcome inflationary impact. As a result, investors should continue to keep as little as possible in savings account. It could be twice the amount of monthly expenses," says Anil Rego, chief executive officer, Rights Horizon, a Mumbai-based financial planning and advisory firm.

Agrees Gaurav Mashruwala, a Mumbai-based certified financial planner. “Everyone needs to keep a contingency fund to meet unforeseen expenses. The fund should be equal to three-six months of monthly expenses. Of this, a substantial chunk should be kept in savings account and the remaining as cash in hand."

FDs, auto sweep-in accounts still have an edge: Despite the hike in savings rate, fixed deposits (FD) over most tenors will continue to provide better returns to investors. For instance, State Bank of India, the country’s largest lender, offers an interest of 4% on maturities between seven and 14 days. For deposits with maturity above 14 days, the bank offers 5%.

Depositors will be better off using the sweep-in facility, wherein as soon as your deposit crosses a certain predetermined limit, it starts earning a fixed deposit rate allowed by the bank. The rate varies from bank to bank.

However, some experts say auto sweep-in may lose some of its charm in any case. “Auto sweep-in facility will lose a little bit of its attractiveness particularly with investors who utilize the facility only for short durations," says S.C. Kalia, executive director, Union Bank of India.

It’s too early to predict which way rates will move in the future. Use your savings account the way you were doing till now; a rate hike doesn’t make it an investment tool and it remains a place to park your emergency funds.

Graphic by Yogesh Kumar/Mint