De-regulation of savings account interest rate by RBI – How good and How bad?
RBI’s second quarter monetary policy review on October 25, 2011 had some expected news and few unexpected surprises. While increase in key policy rates by 0.25% was expected and factored in by many experts, RBI threw in a Diwali Gift with deregulation of savings bank interest rates. Accordingly, each bank will offer uniform rate on savings of up-to Rs 1 lakh. Thereafter, Banks may provide differential rates on savings above Rs 1 lakh. RBI has mandated that savings bank account rate be linked with the policy rate at which the central bank lends short-term funds to commercial banks.
So what does it means for the “aam janta” and where do interest rates go from here?
Savings Account is meant for the common people, for the retail customers like you and me and hence deregulation of the savings account interest rates holds large implications. Further it is going to have an indirect impact on the overall flow of funds and the lending scenario in the Indian Economy. RBI has come a long way from converting savings account from a cheap source of money to banks, to a prudent investment and savings avenue. It started with mandating banks to calculate interest rate on outstanding balance on a daily basis instead of monthly, then increasing savings account rate to 4% and now finally deregulating the rates. On the savings side it translates into better returns for docile investors, increased competition amongst banks and possibility of improved savings products. What can be a dampener would be a higher lending rate by banks due to increased cost of funds.
The most obvious benefit is the increased return to regular savers on their money lying in normal savings account. For those who tend to be less financially prudent about their money lying idle in their salary accounts, this would result in better returns. Further short-term deposit rates are also expected to rise which will help old age investors and pensioners looking for short-term deposits and debt funds as investment opportunities.
Further the competition amongst banks will increase which if effectively monitored and controlled would lead to increased efficiencies in the banking space. Increased competition will lead to development of innovative products thereby transforming the savings account from a bank account to a safe & secure investment avenue. This will increase the attractiveness of savings deposit account, which is expected to improve the savings profile of a common man. This increased competition does call for caution and prudent management by RBI as innovative products can be dangerously complex for the common people to understand and which could be largely aimed at old age investors and pensioners to whom banks can try to sell complex customized debt products linked to savings account. Another downside could be that banks would try to make up for the increased cost through increased transaction charges and other hidden costs on savings account, which would hurt the small investors and the common man, who keep their entire income in the savings account. Banks which have many low value savings accounts would be hurt the most and may try to increase minimum balance required in account to dissuade low value account holders like the no-frill’s account. This poses a threat to financial exclusion. RBI has to be prudent and monitor such activities and place effective measures that the interests of people are taken care of.
The competition can also be detrimental to the banking system itself. In an attempt to improve their CASA ratio (CASA ratio is the ratio of current account and savings accounts deposits in a bank to it’s total deposits), banks with little CASA outstanding as of now would increase their savings account rate quite high to attract more account holders. Although interest rates are just one of the factors to be considered while opening savings account, private sector banks would definitely look at exploiting this. This frenzy over interest rates would create instability in the system. The most affected would be public sector banks with wide reach in rural areas where low value accounts are dominant. From a more technical perspective, the shift in deposits from among banks might create asset-liability mismatch although possibility of such massive shifts in deposits are less likely.
Another more prominent impact would be on the lending rates. With increasing key policy rates already impacting the lending rates, the increased savings account rate would further pressurize the banks to pass on the burden of rising cost of funds to the customers. This would make life difficult for people under the burden of loans in the form of increased EMIs. A prudent strategy for them would be to extend their loan tenure if possible to reduce EMIs and continue servicing EMIs.
Deregulation of saving bank interest rate is certainly a healthier step towards better financial benefits to the common masses. It is expected to lead to a more open banking systems and better translation of RBIs policies to the market. What is now needed is effective monitoring and implementation of the deregulation so that any irregularities are addressed before they can hurt the investors at large. Banks on their part have to assume a very responsible mode of utilizing this deregulation to strengthen their product portfolio and offer customers an informed and better financially suited product profile.