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savings rate increases to 4

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The money lying in your bank accounts will now earn you 0.5% more. After a period of 8 years, the RBI on May 3rd announced an increase in the bank savings rate from 3.5% to 4%. Reeling under the impact of high loan servicing charges and inflation, this is a small but welcome relief. The bank savings interest rate is regulated by RBI, hence all banks have to offer the same interest rate. This will serve as a good incentive to divert cash into the banking channels.


The Reserve Bank of India, recently has released a discussion paper to the public, inviting comments on the de-regularisation of the bank account interest rates. De-regularisation means that banks are free to fix their own interest rates on savings deposits. For e.g. a bank with less liquidity who wants to attract funds for assets may offer a higher interest rate on the savings deposit. On the contrary a bank with excess liquidity may end up matching the rate to remain competitive but the cost of funds for the bank will also increase finally letting the burden rest on borrowers.


In the discussion paper, it refers to the time deposit interest rates which are de-regulated and each bank is free to fix its own rate for a tenor. While the de-regulation regime brought in intense competition among the banks to attract deposit customers, it has enabled price discovery and efficiency in the system. The initial fears of cannibalization and extreme differentials have been nullified. The difference in the rates offered by banks is around 50 bps and may not be incentive enough for a customer to move his funds from one bank to another. There was not significant asset liability mismatch between banks as a result of this de-regularisation.


However, the RBI did mention that deregulation of savings deposit rate may hurt banks’ profitability though it will improve transmission of monetary policy. Savings deposits that form 22% of banks’ total deposit base are a source of low-cost funds for them, and deregulation may lead to unhealthy competition, thereby pushing up cost of funds of the banking sector. However, bankers don’t expect the transition to a fully deregulated regime to happen soon and feel that it has to be done in phases.


On benefits of the deregulation, the central bank said it will aid in monetary policy transmission. For transmission of monetary policy to be effective, it is necessary that all rates move in tandem with the policy rates. This process, however, is impeded if the interest rate in any segment is regulated, the RBI said in the paper. 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, the RBI said in the paper.


The RBI also said most developed countries have deregulated the savings bank deposit rates. The paper is open for comments until May 20th. While banks have a cause for worry and if implemented this may bring about price discovery and cost efficiencies in the system. This is wait and watch but for the small savers like you and me, this is a reason to smile.


Source: InvestmentYogi

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