Why are
Savings Bank
interest
rates deregulated?
Rama Krishna Vadlamudi,
|
||
Reserve Bank of India has given freedom to
banks to set their own interest rates on Savings Bank deposit accounts. Till
now, SB deposit interest rates were decided by RBI and banks offered RBI’s
uniform rate to SB accountholders. On 25 October 2011, RBI announced
deregulation of SB interest rates with immediate effect. The same day, Yes Bank
raised its interest rate on SB deposits by 200 basis points (or two per cent)
to six per cent. Let us analyse certain issues related to the deregulation of
SB interest rate.
What is interest rate
deregulation?
As banking sector regulator, Reserve Bank of India
Allowing banks to have more autonomy, RBI had undertaken
the process of deregulation and started giving freedom to banks to offer their
own rates in 1992. Except Savings Bank deposit interest rates, all the deposit
rates were deregulated by RBI in 1997.
On the lending side, the rates on small loans up to Rs 2
lakh and rupee export credit were deregulated in July 2010, when Base Rate was
introduced replacing the benchmark prime lending rate (BPLR) system.
Why are
Savings Bank deposits so important for the economy?
Household financial assets are 10.4 per cent of India
Around 85 per cent of SB deposits are held by household
sector which include senior citizens, small savers, pensioners, salaried class,
small businessman, and others.
Why did
RBI deregulate Savings Bank interest rates?
The deregulation of SB deposit interest rates is part of
the process of financial sector reforms and bank autonomy initiated by RBI in
1992.
RBI wants to make SB deposits more attractive to savers.
Deregulation will stimulate banks to offer more SB products and better product
innovations. RBI expects that the SB interest rate deregulation will improve
the effectiveness of monetary policy transmission.
In view of the above, RBI had deregulated interest rates
on SB deposits with immediate effect when it announced the second quarter
review of monetary policy on 25 October 2011.
Are there any
conditions?
RBI has imposed two conditions on the banks while allowing
freedom to set their own interest rates on SB deposits. They are:
Ø First,
each bank will have to offer a uniform interest rate on savings bank deposits
up to Rs one lakh, irrespective
of the amount in the account within this limit
Ø Second,
for savings bank deposits over Rs one lakh, a bank
may provide differential rates of interest, if it so chooses. However,
there should
not be any discrimination from customer to customer on interest rates for similar
amount of deposit.
This means banks cannot offer different rates based on
area, like, metropolitan city, semi-urban or rural areas. Moreover, a bank
cannot offer different rates, say, for one depositor with Rs 25,000 balance and
another with Rs 70,000 balance (that is, for balances below Rs one lakh).
However, a bank can offer one rate to a depositor, say, with Rs 150,000 balance
and another rate to a depositor with Rs 200,000 balance (for depositors with
balance above Rs one lakh).
Whether
the deregulation is applicable to NRE and NRO accounts?
Interest rate on Non-Resident (External) Accounts Scheme
and Ordinary Non-Resident Deposit under savings account, which has been
prescribed at four per cent per annum at present, will continue to be regulated
until further review, according to RBI.
Will
banks raise SB interest rates?
The competition will surge among banks for SB deposits,
which are low-cost. Already, Yes Bank raised the rate to six per cent the same
day RBI announced the deregulation. State Bank of India
The proportion of SB deposits in total deposits is very
low for banks, like, Yes Bank, IDBI Bank and Kotak Mahindra Bank. As such, they
may offer more rates to their depositors to increase their share of low-cost
deposits and increase their market share.
Banks, like, SBI, HDFC Bank, Punjab National Bank, and
Axis Bank are having higher share of SB deposits in their total deposits. They
too will raise the rates on SB accounts to protect their market share.
As of now, the liquidity is in deficit mode meaning that
banks are struggling to access short-term funds and they are turning to RBI for
their day-to-day operations. It would be interesting to watch the response of
the banks when there is excess liquidity in the system. As was observed during
the 2002-2005 period, banks drastically reduced their term deposit interest rates
to as low as 5.5-6.5 per cent.
It is hoped that the deregulation of SB deposit rates will
not lead to unhealthy competition among banks. Banks are expected to manage the
risks involved in asset-liability mismatches in a better manner even after the
deregulation of SB interest rates. Even though, SB deposits are supposed to be
short-term in nature, a major portion of SB deposits is treated as ‘core’
deposits by banks and banks use SB deposits also to lend to long-term loans.
Who will be benefited
by the deregulation?
As of now, banks are in need of more funds (deficit
liquidity). So, they may increase their SB interest rates to attract more
customers and funds. This is clearly a benefit to savers at present. With
increased rates, banks will be able to attract new customers who will have more
choices now.
Many SB customers use the account for their day-to-day
transactions. Some wealthy customers keep high balances and higher SB rates
will allow them to earn more interest on their SB balances.
If the difference between interest rate on term deposits
and SB interest rate is wide, savers will shift their money from SB to term
deposits. However, if the difference is small, they may keep their money in SB
accounts without bothering about term deposit rates. At present, term deposits
carry interest rates of 8 to 10 per cent, which is stimulating depositors to
keep more money in term deposits rather than in SB accounts.
The benefit to existing customers who are having ‘sweep’
facility may not be large. Sweep facility in SB accounts allows the customers to
move excess money beyond a certain limit to fixed deposits; and to move the
fixed deposit amount back to SB account when a customer issues a cheque or
needs funds.
The flipside of deregulation is that when banks are not in
need of funds (surplus liquidity), they may decrease the interest rates on
deposits – both term deposits and SB deposits. In such situations, interest
rate differential between term deposits and SB deposits may come down lessening
the attractiveness of SB deposits as happened during the 2002-2005 period.
How does the rate hike
impact banks?
Cost of SB deposits has already gone up for banks before
the SB deposit interest rate deregulation. From April 1,
2010, banks have been giving interest rates on SB account based on daily
product. With effect from 3 May 2011, banks have been paying four per cent
interest rate on SB deposits compared to 3.5 per cent earlier.
The cost of SB deposits will further go up from now with
the advent of competition from SB interest rate deregulation. Different banks
will get impacted differently depending on several factors – like, branch
location, nearness of branch, facilities provided under SB accounts, technology
platform, and alternative delivery channels.
It remains to be seen whether banks will pass on the
higher cost of funds to customers. Depending on the competition, banks may
increase their transaction and service charges for SB customers.
However, there are limitations to passing on the higher
costs as any adverse reaction from depositors will cause reputation risk to
banks. Banks which are enjoying higher net interest margins (NIMs) may absorb
the higher cost – from hike in SB deposits – themselves for the time being.
What should investors
in bank stocks do?
As has been pointed out earlier, the SB interest rate
deregulation and the consequent increase in cost of deposits will impact banks
differently depending on the number of branches, branch location and quality of
service. Quality of service, branch location, branch network and product design
play a major role in customers’ choices.
For example, Yes Bank is having around 200 branches. The
bank may be able to attract new SB customers to its fold in locations where it
is having branches. However, it cannot pose any threat to banks in other
locations unless it expands its branch network to those locations.
Issuance of new bank licenses will take some more time if
one considers the long process of decision-making on the part of regulators and
lawmakers. Real action will start when new banks enter the fray after the new
licenses are issued by RBI.
Competition has two sides to it – both positive and
negative. The impact from competition hinges on individual bank’s agility.
In view of the above, it may take more time before the
real competition starts to hurt the existing banks which enjoy higher share of
SB deposits. As such, investors in bank stocks need not panic provided they are
holding stocks of fundamentally sound banks.
Criticism of the SB
rate deregulation
The deregulation of SB deposit interest rate has attracted
criticism from several quarters. Some critics questioned the timing of the
deregulation. Banks which enjoy higher share of SB deposits are not comfortable
with the deregulation.
There are several rates in the system, which are not
deregulated distorting the interest rate environment in the economy. The
interest rates on public provident fund (PPF), provident fund, national savings
certificates (NSC) and post office deposits continue to be administered by the
Government of India. These rates do not move in line with the market interest
rates (These rates were last changed in 2001/2002).
As such, there is a need to have a relook at all the
administered interest rates in the country and make them market-determined as
has been suggested by various committees in the past.
- - -
References: RBI
Abbreviations: GDP – Gross
Domestic Product or national income.
Appendix
Some important data for 2008-09:
Ø
Gross
domestic savings are 32.5 per cent of GDP at market prices.
Ø
Household
sector savings are 22.6 per cent of GDP.
Ø
Out
of the household sector savings, financial assets are 10.4 per cent of GDP and
the remaining are physical assets.
Ø
Share
of total bank deposits is 54.9 per cent of total household financial assets.
Ø
Share
of savings bank deposits is 12.8 per cent of total household financial assets.
Ø
Share
of currency is 12.5 per cent of total household financial assets.
Ø
As
at the end of March 2009, total savings bank deposits are around Rs 8.96 lakh
crore.
What is monetary policy
transmission?
Ø
Whenever RBI raises or lowers policy rates, banks are expected to
revise their interest rates in tune with the RBI. The intentions of RBI will be
carried through the commercial banks to the entire economy. Banks pass on the
RBI’s policy measures either by increasing the lending and deposit rates or by
lowering them in tune with the RBI’s policy measures. This is called Monetary
Policy transmission.
Ø
Effective monetary policy transmission entails that all rates must
move in tandem with RBI’s policy interest rates. This process is hampered if
any interest rate is regulated. Savings Bank deposits constitute around 22 per cent
of total deposits (2009) and as such SB interest rate deregulation is important
for effective monetary policy transmission.
Note on author: Author is an
investment analyst and writer. The views are personal and this is written only
for information purpose. Readers are advised to consult their certified
financial adviser before taking any investment decisions.
Author’s articles on financial
articles can be accessed at:
No comments:
Post a Comment