Freeing interest rates on savings deposits may give better returns and provide more options
Inflation has, over the past seven years, consistently outpaced returns to savers. The move to free savings rates is expected to trigger product innovation
among banks. RBI, on its part, hopes that depositors will benefit not
just from higher interest rates, but also from more choices.
Reserve Bank of India Governor Duvvuri Subbarao is not easily persuaded. Both his admirers and his critics have learnt this through the 13 interest rate hikes he has effected over the past 18 months. More proof came on October 25, when Subbarao announced savings rate deregulation, ignoring bankers' pleas to defer the step until the current volatility in the economic environment subsided. Of course, he had his reasons for doing so.
Savings rates were the last administered interest rates. After March 1, 2003, the savings rate had been changed only once - it was raised from 3.5 per cent to four per cent in May 2011.
This effectively meant that except for a six-month period, inflation had consistently outpaced returns to savers over the past seven years. Households, which, according to RBI, account for 84 per cent of savings deposits, lost the most in an era of high inflation.
Savings rate revamp to bring in change
For the central bank, calibrating monetary policy through interest rate changes when savings deposits made up about 22 per cent of banks' deposit base, was tantamount to driving with the handbrake pulled up.
Fear of reckless rate increases by banks due to competitive pressures made RBI cautious in dismantling controls. "There may not be such intense competition for deposits now. We thought this might be a good time to do it," Subbarao told the media after freeing savings rates. Moreover, when fixed deposit rates of banks were freed in 1997, there had been no resultant shocks.
Savings deposits have no lock-in and are thus, theoretically, the most fickle deposits. But RBI data between 2001 and 2009 shows that savings deposits as a proportion of banks' advances remained steady around 21.5 per cent. However, the proportion of long-term deposits - those of over three years' duration - has dropped to 20 per cent from 31.7 per cent, triggering anxiety about banks running into liquidity problems.
RBI Governor D Subbarao says banks still have much left lot to do within the economy
The regulator, however, decided it was time to bite the bullet. While giving banks the freedom to set interest rates on savings deposits, RBI has mandated that all savings deposits up to Rs 1 lakh will have to be offered the same interest regardless of the balance. If the balance exceeds Rs 1 lakh, banks can offer differential rates provided they do not discriminate between customers holding the same balance.
Two banks, YES Bank and Kotak Mahindra Bank, have already increased the savings deposit rate by two percentage points to six per cent. Savers, however, need to prepare for a two-way movement.
"It is a good step, but in the medium run, rates could swing either way as we are at a peak of the rate cycle," says Munish Dayal, Partner at Barings Private Equity. Rating agency CRISIL estimates that competition among banks will push up the average savings rate by 50 to 100 basis points. This should translate into an additional Rs 9,000 crore for people with savings bank accounts.
Eventually, the net gains for households may be limited. RBI says about 64 per cent of savings deposits are held in urban centres and the balance in semi-urban and rural areas. Urban savers are influenced by conveniences such as free cheque books and online payment facilities for utility bills and not just by interest rates. Along with higher interest rates, banks might begin to levy charges on some conveniences. "The quantum of benefit is not going to be very material for savers," says Dayal.
For banks, an increase in interest rates will eat into their profits. The impact on public sector banks will be severe as they control about 87 per cent of savings deposits in India. SMC Global Securities estimates that a one percentage point increase in the average savings deposit rate will mean banks having to pay out an extra Rs 14,469 crore as interest.
Based on 2010/11 balance sheets, an additional percentage point increase in average interest rates will dent banks' profit before tax of Rs 1.12 trillion by 12.85 per cent.
As a positive, the move to free savings rates is expected to trigger product innovation among banks. RBI, on its part, hopes that depositors will benefit not just from higher interest rates, but also through more choices.
"Deregulation will allow banks to introduce product innovations, which could also benefit the depositors," an RBI discussion paper on the subject released in April 2011 concludes. Dayal echoes RBI's conclusion, saying: "There will be more innovation and more value add on balances."
Savings rates were the last administered interest rates. After March 1, 2003, the savings rate had been changed only once - it was raised from 3.5 per cent to four per cent in May 2011.
This effectively meant that except for a six-month period, inflation had consistently outpaced returns to savers over the past seven years. Households, which, according to RBI, account for 84 per cent of savings deposits, lost the most in an era of high inflation.
Savings rate revamp to bring in change
| 11.7% drop in long-term deposits, has triggered fears of banks running into liquidity problems |
Fear of reckless rate increases by banks due to competitive pressures made RBI cautious in dismantling controls. "There may not be such intense competition for deposits now. We thought this might be a good time to do it," Subbarao told the media after freeing savings rates. Moreover, when fixed deposit rates of banks were freed in 1997, there had been no resultant shocks.
Savings deposits have no lock-in and are thus, theoretically, the most fickle deposits. But RBI data between 2001 and 2009 shows that savings deposits as a proportion of banks' advances remained steady around 21.5 per cent. However, the proportion of long-term deposits - those of over three years' duration - has dropped to 20 per cent from 31.7 per cent, triggering anxiety about banks running into liquidity problems.
RBI Governor D Subbarao says banks still have much left lot to do within the economy
The regulator, however, decided it was time to bite the bullet. While giving banks the freedom to set interest rates on savings deposits, RBI has mandated that all savings deposits up to Rs 1 lakh will have to be offered the same interest regardless of the balance. If the balance exceeds Rs 1 lakh, banks can offer differential rates provided they do not discriminate between customers holding the same balance.
Two banks, YES Bank and Kotak Mahindra Bank, have already increased the savings deposit rate by two percentage points to six per cent. Savers, however, need to prepare for a two-way movement.
"It is a good step, but in the medium run, rates could swing either way as we are at a peak of the rate cycle," says Munish Dayal, Partner at Barings Private Equity. Rating agency CRISIL estimates that competition among banks will push up the average savings rate by 50 to 100 basis points. This should translate into an additional Rs 9,000 crore for people with savings bank accounts.Eventually, the net gains for households may be limited. RBI says about 64 per cent of savings deposits are held in urban centres and the balance in semi-urban and rural areas. Urban savers are influenced by conveniences such as free cheque books and online payment facilities for utility bills and not just by interest rates. Along with higher interest rates, banks might begin to levy charges on some conveniences. "The quantum of benefit is not going to be very material for savers," says Dayal.
For banks, an increase in interest rates will eat into their profits. The impact on public sector banks will be severe as they control about 87 per cent of savings deposits in India. SMC Global Securities estimates that a one percentage point increase in the average savings deposit rate will mean banks having to pay out an extra Rs 14,469 crore as interest.
Based on 2010/11 balance sheets, an additional percentage point increase in average interest rates will dent banks' profit before tax of Rs 1.12 trillion by 12.85 per cent.
As a positive, the move to free savings rates is expected to trigger product innovation among banks. RBI, on its part, hopes that depositors will benefit not just from higher interest rates, but also through more choices.
"Deregulation will allow banks to introduce product innovations, which could also benefit the depositors," an RBI discussion paper on the subject released in April 2011 concludes. Dayal echoes RBI's conclusion, saying: "There will be more innovation and more value add on balances."
