Make it free and be fair to bank customers

The process of economic reform that started in the year 1992 has brought in major changes in the regulated regime of banking and financial sector. The biggest change came in the form total  deregulation of interest rates on bank term deposits in the year 1997. The next big step in reform was in 2010 when banks were told to implement ‘Base Rate’ system against the ‘Prime Lending Rate’ to calculate lending rate of interest for all borrowings.

But the interest rate on savings bank account is one important element in banking that continued to be regulated by the country’s central bank - the Reserve Bank of India (RBI) and since 2003 the rate of interest in savings has remained unchanged at 3.5 per cent.
Seeking feedback from banks, RBI has recently released a discussion paper on freeing up savings interest and from the line of argument in the paper it appeared that RBI is quite keen to see this deregulation through. In fact, many are of the view that the increase in savings interest rate from 3.5 per cent to 4 per cent in RBI’s monetary policy announced last week, is a precursor to deregulation. “I think the signals are very clear that savings interest rates will be soon freed. It will be good for the depositors and banks will have to learn to live with it,” said Vijaya Bank CMD H S Upendra.

Stakes are high

Though there will be divergent views from bankers and experts, majority believe that deregulation of savings interest will do good to depositors and banks in the long run.
First and foremost, there is no incentive for the depositors to keep money in the savings account because high average rate of inflation of around 8 per cent means depositors lose 4 per cent of the value of even after earning 4 per cent interest. Though there is no guarantee that after deregulation, savings interest will always remain high, it can also go down, one will be happy that it will be driven by the market forces just like term deposit rates.

Stakes are also high as we are talking about a huge sum of money of Rs 11,71,500 crore lying in savings accounts of all banks put together in India. This amount accounts for a significant 22 per cent of total deposits in banking industry.

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. RBI feels that freeing up savings interest rates will make banks more aggressive to tap unbanked population and 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 organised banking system.

In this context SBI Chairman Pratip Chaudhuri said, “For a bank like ours, it (hike in savings interest) does (augurs well) as people are keeping Rs 9.5 lakh crore at home in cash because of the low interest rate (on savings deposits). They are not comfortable in committing money in long-term deposit."

He is right as 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 nearly half of household investments are not coming to the banking industry.

Low penetration

Though India’s population has exploded over the years, total number of savings account in the country at the end of 2008-09 was only 8.96 lakh with a concentration of 36 accounts per 100 people. The RBI data also shows that 84 per cent of savings accounts are owned by household sector but there is a wide divergence in numbers between rural and urban sector.

In 2008-09, according to RBI data, 64 per cent of total savings bank deposits were in the towns and cities while only 36 per cent were in rural areas. Freeing up savings interest rates may encourage banks to enlarge their spread to capture more rural clients. “With core banking technology riding on spread of telecom network banks can now reach out to many remote villages at a low incremental cost”, said a senior official in SBI. Said Assocham Secretary General D S Rawat: “A large volume of bank deposits parked in savings accounts is currently facing severe negative returns. Let there be a competitive environment where cost reduction determines the capability, and not regulated interest getting access to low-cost funds.”

Others have done it

Many countries in Asia experimented with interest rate deregulation to support overall development and growth policies. Interest rates were fully deregulated in Singapore in the mid-1970s, and in the Philippines, Indonesia and Sri Lanka in the early 1980s. Malaysia, Thailand and the Republic of Korea engaged in a gradual deregulation process, characterised by more frequent adjustments and the removal of some ceilings. Hong Kong also deregulated in phases by July 2001. This involved the removal of the interest rate cap on savings accounts and the prohibition of the payment of interest on current accounts.

A senior official of the Department of Financial Services in the Finance Ministry said, “After studying responses from all stakeholders on its discussion paper, RBI is expected to take a holistic stand. Factors like probable impact on banks overall cost of fund will have to be taken into account.”

There is no doubt that depositors will benefit, freeing up interest rate may add to the cost for banks. According to analysts, the recent 50 basis points (bps) increase in savings interest rate, for example, will make banking industry pay nearly Rs 6,000 crore by way of additional interest. It is estimated that on an average, interest cost for banks will go up by between 10 to 15 bps in a year.

Banks may partly offset higher cost by levying fees for some services like issuing of cheque books beyond a minimum number of leaves. State Bank of Mysore Chairman and Managing Director Dilip Mavinkurve, however, feels that depending on the demand and supply situation of funds interest rate can even go down. “We are not worried, the additional cost (on savings deposits) will become part of the lending rate calculations and will be passed on. If there is no floor, we may even see interest rate going down,” he said.

Kamath of Vijaya Bank also feels that the cost push will be negligible. SBI Chairman Chaudhuri thinks that the cost may actually go down. He said, “… by attracting more money in savings account SBI will be able to lower the overall cost of deposits.”
 
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. A major attraction of savings deposits for banks is that it offers a low cost source of funds.

Typically, majority of the public sector banks and one large private sector bank has higher share of CASA (current account and savings account) deposits ranging between 30 and 40 per cent (of which savings deposit is a major component) and they enjoy relatively low cost of deposits. These banks together also account for nearly half of total asset of the banking sector. Therefore, given the attractiveness of savings deposits, it could be argued that deregulation may lead to unhealthy competition amongst banks eat into margins.

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 banking. 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,” said Yes Bank Group President and CFO Rajat Monga.

Innovative options

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, said Monga. Customers may also get higher interest if he agrees to keep a high minimum amount. 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 that deregulation of savings deposit interest rates has both pros and cons. But the RBI is of the view that savings deposit interest rate cannot be regulated for all times to come when all other interest rates have already been deregulated as it creates distortions in the system. International experience suggests that in most of the countries, interest rates on savings bank accounts are set by the commercial banks based on market interest rates. These resulted in positive real interest rates, which in turn contributed to an increase in financial savings which is good for the economy.
(With additional reporting by Aditya Raj Das from New Delhi.)