It’s party time for lazy investors. There are many among us who leave large amounts of cash in banks’ savings accounts without making any effort to maximise return on them. But things are now changing for the better. Ever since the Reserve Bank of India (RBI) freed banks to fix interest rates on savings account two weeks ago, this was the last piece of banking reform that started 20 years back, with commercial banks vying with each other to attract investors by raising savings interest rates.

Three major new private sector banks - Yes Bank, Kotak Mahindra Bank and IndusInd Bank - have already raised interest rates by 50 per cent to 6 per cent from 4 per cent for deposits above Rs 1 lakh and to 5.5 per cent for deposits below Rs 1 lakh. The difference in interest rates, according to Fitch Ratings’ Senior Director Ananda Bhoumik, is because accounts with less than Rs 1 lakh balance are seeing more of transaction accounts while accounts with more than Rs 1 lakh will be viewed as fixed deposits by banks.

The public sector unit banks (PSU banks) are soon to follow suit, as the largest PSU bank, the State Bank of India, has indicated that it may raise the savings interest rate by up to 150 basis points (bps) or by 1.50 percentage points. Other PSU banks like Canara Bank, Vijaya Bank, Bank of Baroda and do on have said that they are studying the new scenario and may announce the rate hike in the next two weeks. “The move (increase in savings interest) will certainly help customers and make them keen to get higher return.

Of course, banks’ cost of fund will go up but we will have to learn to live with it,” says Vijaya Bank Chairman and Managing Director H S Upendra Kamath. But it is also possible that in a declining interest rate scenario, the interest rate can even go down.

Says State Bank of Mysore (SBM) Managing Director Dilip Mavinkurve, “It can cut both ways as interest rates can also go down. Besides, with comfortable liquidity in the system, banks may also lower interest rates on fixed deposits to compensate for higher cost of savings deposits, to some extent.”
 
Many positives

Surely, more income from savings deposits will help at a time when high rate of inflation is making everyone poorer. First of all, according to SMC Global Securities, if the banks raise interest rates by 100 bps (1 percentage point) the benefit to depositors (or cost to banks) will be to the tune of Rs 14,460 crore in a year.

It is also expected that the added incentive will bring a large portion of idle cash in the economy, estimated to be around Rs 9.50 lakh crore, into the banking system.  Even though India has a long history of banking, a vast majority of the population still remains unbanked because of the poor penetration of banking services in the rural areas. The RBI feels that freeing up savings interest rates will make banks more aggressive to tap the unbanked population and a greater number of people will see value in keeping money with banks than under the mattress. In short, money will become more productive as more of household savings will be routed to the organised banking system.

Stakes are also high as we are talking about a huge sum of money, Rs 14,46,900 crore, at the end of March 2011 lying in savings accounts of all banks put together in India. This amount accounts for a significant 22 per cent of total deposits in the banking industry.
The scope to tap more savings is huge. According to RBI data, the share of bank deposits in total household assets was only 55 per cent in 2008-09 and within that, the share of savings deposits was only 13 per cent. This means that nearly half of the household investments are not coming to the banking industry.

Wrong timing

While bankers welcome the deregulation, many felt the timing was wrong as the industry is already suffering from high interest cost, due to the banking regulator, RBI, hiking interest rates 13 times in the last 20 months or so. As Vijaya Bank’s Kamath and SBM’s Mavinkurve pointed out that in view of the slight slowdown in the economy, the credit off-take is already a bit sluggish. To add to it, the higher lending rates are making borrowers feel the pinch and the hike in savings interest will now make things worse.

Banks will have no choice but to pass on the increased cost to the borrowers who are already complaining about high cost of fund. In fact, two of the three banks who raised savings interest, have already announced 25 bps increases in their base lending rates. Retail customers borrowing money to buy home or cars will also have to pay for the higher cost.  

Eat up profits

It is almost certain that banks will have to absorb a part of the higher interest cost and sacrifice their profits. The impact of a saving interest rate hike on the bottom line will vary according to the proportion of deposits in current account and savings account (CASA) for a bank. For example, SBM will have an added cost of 50 bps if it increases interest by 200 bps to 6 per cent because its savings deposits account for 25 per cent of the total. 

According to an estimate, for large banks like ICICI, HDFC, SBI, Punjab National Bank, Bank of Baroda, etc, the impact on net interest margin will vary from 31 bps to 57 bps if the savings interest rate goes up by 150 bps. Angel Broking Research’s Vaibhav Agrawal calculated that a 100 bps increase in savings rate would have a 20 basis points impact on the total cost of funds for the banking industry.

In this context, HDFC Bank CEO Aditya Puri says, “Though we are yet to quantify the cost for hiking savings rate deposits, in the worst case, there will be a margin pressure of 25 basis points if we increase savings deposit rate by 100 basis points.” It is generally believed that PSU banks and old private banks having larger CASA ratio will end up incurring higher cost for hikes in savings interest rates compared to new private banks having low CASA. Banks may partly off-set higher cost by levying fees for some services like issuing of cheque books beyond a minimum number of leafs and for other tailor-made services.

More competition

Many fear that in a deregulated regime, there will be fierce competition among banks to grab more money in savings accounts and this will lead to unhealthy competition.
Even if banks start fighting with each other for larger share of savings account wallet, there is nothing wrong, feel many bankers. This is already happening in term deposits which account for nearly 60 per cent of total deposits in the banking sector. New private banks with fewer bank branches and lower CASA ratio will surely try to attract more money by offering sweeteners. “We shall see many innovations in savings products as competition is bound to hot up,” says Vijaya Bank’s Executive Director, Subhalakshmi Panse.  

Product innovations
After deregulation, banks may offer different options in savings accounts. We may see different tiers of rates depending on the service a customer accepts. A low maintenance customer who does not go to branches at all and does most of his transactions online or using ATMs, may be rewarded by higher interest compared to a customer who uses cheque facility and uses branch banking facility more often.

Customers may also get higher interest if they agree to keep a high minimum amount, which is already taking place as banks are offering 50 bps more interest for deposits above Rs 1 lakh. Sweeping facility that allows back and forth fund transfer between savings and term deposits beyond a pre-agreed minimum amount will also become more popular.

Agreed the timing of deregulation was not ripe enough and banks will take a profit hit, but there is no denying the fact that the RBI move was in the right direction as savings interest rate cannot be regulated forever when all other interest rates have already been deregulated. International experience also suggests that in most countries, interest rates on savings bank accounts are set by the commercial banks based on market interest rates, which resulted in positive real interest rates, in turn contributing to an increase in financial savings and doing well for the economy.

(With inputs from Suresh Nandi)