De-regulation of Savings Bank interest rates

The major development during the last week was the de-regulation of the savings banks interest rates of banks in India by the Reserve Bank of India. This is one of the last of administered interest rates in the banking industry and which has an impact on both the parties involved, the customers and the banks. We wholeheartedly welcome this move of Reserve Bank of India as it would lead to finer pricing of savings bank deposits to the customers.

Savings Bank deposits are the most common of the banking relationship the customers have with their bankers. Around 20 to 25% of the banking deposits are in Savings Bank accounts. So what does the de-regulation mean in layman terms? RBI has now allowed banks in India to offer an interest rate which is not mandated to them. They are free to price their savings bank interest rates to attract new customers. RBI has mandated two slabs, for SB account with balances less than Rs100,00 and SB accounts with balances more than Rs100,000. The banks can offer differing rates for these two categories, which I think is very logical. Couple of banks have already raised their SB interest rates. Yes Bank was the first of the block, raised its SB interest to 6%. More banks are expected to follow suit in the days to come.

How does it benefit the customers? The balance lying in the SB account would get higher interest with effect from the Q3 of 2011-12 Financial year. But the customers should also note that with the freeing of interest rates, the interest rates can also go down as and when we see a cheap money policy. That is, when the overall interest rates come down, the SB interest rates would also be coming down and there is no floor stipulated by RBI. Just like the FD interest rates are ruling high currently, the SB interest rates would also be high and may even go up to 7% or so in the coming months, but with inflation coming down (RBI expecting this to happen in Q4) the interest (repo) rates would also come down. Along with that, SB interest rates would also come down. So it is no longer going to be one way street!!

So the point to be noted here is that there is no minimum guaranteed interest rates on SB deposits going forward. This makes it very important for people with high SB account balances to actively manage these funds for better returns. It is not sufficient to just leave it in SB accounts to earn these high interest rates forever.

There would be initial euphoria for this announcement and I expect a flurry of announcements by banks trying to entice customers. There would be increased pressure on the margins of the banks which has a very high quantum of SB account balances, like HDFC, SBI etc., As a result the cost of funds for the banks would increase proportionately to the ratio of Savings Bank accounts in their deposits.

Banks are smart and they would definitely try to pass on this increased cost of funds to the customers in a different manner. They would restrict the number of transactions allowed in a savings bank account per quarter, number of branch visits and anything above the allowed limit would be chargeable for the customers. There is no free lunch in the system!

But over a period of time, the impact on banks because of this new regulation would even out. Actually, in my opinion, banks would stand to gain in the long run. The interest rates would come down but the transaction charges and the limits imposed would remain for the customers. Gain in the short term but its going to be pain in the long term for SB account holders. I wish I am wrong here!!!!