Unleashing rate war
Implementation of deregulation of savings account rate needs effective monitoring so that any irregularities are attended to before they cause harm to depositors.
At the fag end of the last month, Reserve Bank of India in its second quarter monetary policy review on October 25, dished out a huge unexpected surprise. The central bank announced deregulation of savings bank interest rates with immediate effect. It directed that 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.
What does this deregulation of savings bank interest rate means for a common bank customer? Before discussing the impact of this deregulation, let me tell you about the Savings Bank Account, which I think is the basic cord of banker-customer relationship.
In today's context, Savings Bank account constitutes a vital part of common man's, financial scenario. When a common man like you and me think about safety of money, a savings bank account straight way comes to our mind. This is the account which offers us easy access to our cash and can make cash withdrawal easily and quickly.
So the safest thing to do with money is to put it into a savings account. The money in a savings bank account at the same time multiplies as the bank provides interest on the amount deposited in the account.
In the context of the nature of Savings Bank Account, the deregulation of rate of interest in the account holds large implications. Deposits in saving account constitute a huge 13% of the overall savings in financial assets for individuals. Further it also constitutes 22% of the total deposits of scheduled commercial banks. Thus any change in interest rate on saving deposits has a major impact both on the bank as well as on the depositor.
Notably, the central bank as a first step to deregulate saving deposit rates, hiked the savings bank deposit interest rate from 3.5% to 4% in May this year. The rate had remained unchanged at 3.5% since March 1, 2003. Before raising the rate of interest, the apex bank had announced a new formula for applying rate of interest on savings bank accounts. By virtue of the new interest calculation formula the banks have been calculating interest to be paid on money kept in the savings bank account on a daily basis from April 2010. Today, a savings bank account holder earns 16-18% more on every rupee in the account.
Prior to this new interest calculation formula, the returns on the money kept in the savings bank accounts were sometimes zero, not the 3.5% that they assumed were getting. The formula of calculating the savings bank interest rate was unfair as it was paid on the minimum balance held between the 10th and 30th /31st of every month till March 31, 2010.
Later the change in calculation of the interest paid on money kept in the savings bank account translated to the higher earnings for the depositor. The interest is calculated on a daily basis, and credited to the account at the end of each quarter.
So, converting savings account into a prudent investment and savings avenue started with RBI directing banks to calculate interest rate on outstanding balance on a daily basis instead of monthly. Then, it followed with increasing interest rate to 4%. Now finally deregulating the rates has on one hand put the banking community in a dilemma and on the other many forecast yet again a merry time for the savings account holders, as they would be getting higher rates for their money lying idle in their savings accounts.
What's the impact of this deregulation? If viewed on the savings side, it translates into better returns for investors. Obviously, the increased return, particularly to those who are less financially careful about their money lying idle in their accounts is a major benefit to them. But this means the cost of deposits for the banks would go up. It also unleashes increased competition amongst banks and there is every possibility of innovative savings products/ schemes in near future. When we talk of increased competition among banks, it means transforming the simple savings account from a bank account to a secure investment avenue. This attractiveness of savings deposit account is expected to improve the savings profile of a common man. Since the cost of funds is going to increase, the banks would be forced to hike their lending rates, thereby meaning the loans would become costlier. This would make life difficult for people under the burden of loans in the form of increased EMIs.
Since cost of funds for the banks would be now higher, there's every possibility that that banks would try to make up for the increased cost through increased transaction charges and other hidden costs on its products and services. There is a breed of new generation private sector banks which are quick enough to pass on the higher costs in the form of higher loan rates or transaction charges or mix of the two. So this time too, they would be luring the gullible customers through higher rate of interest on savings accounts, but at the same time they would be making them to cough up additional amounts for some products and services.
The apex bank has deregulated the rates, but a major challenge is to put in a mechanism in place which can track effective monitoring and implementation of the deregulation so that any irregularities are attended to before they harm the depositors at large.
Notably, the deregulation move has also been discussed as a test of loyalty of customers. Will customers switch over to the banks which offer higher rate in savings accounts? This is the most common question probing the minds of analysts. But I don't think majority of the customers of a particular bank would be shifting to some other bank just for increased rate offer. The savings bank account is not actually opened for earning interest but to be able to access the money for small meeting needs. Above all, savings account is the basic account through which the accountholder is enjoying other products, services and facilities of the bank. The shifting of loyalty on this premise would be a loss making proportion to the customer alone.
Quote: There is a breed of new generation private sector banks which are quick enough to pass on the higher costs in the form of higher loan rates or transaction charges or mix of the two. So this time too, they would be luring the gullible customers through higher rate of interest on savings accounts, but at the same time they would be making them to cough up additional amounts for some products and services.
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