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!!!!

EPF rate kept unchanged at 8.5 per cent for 2008-09

The Central Board of Trustees of the Employees Provident Fund met here on Sunday pegged the interest rate payable to subscribers for 2008-09 at the existing 8.5 per cent for the third successive week against the trade unions' demand for 9.5 per cent return per annum.
The decision was taken by the newly constituted board which met under the chairmanship of Oscar Fernandes, minister of state for labour and employment and chairman, central Board of Trustees of EPF in New Delhi.

The decision to keep the interest rate at 8.5 per cent for the current financial year has been opposed by almost all major trade union leaders, including the Centre of Indian Trade Union (CITU), All India Trade Union Congress (AITUC), Bhartiya Mazdoor Sangh (BMS), Hind Mazdoor Sabha (HMS) and All India United Trade Union Centre (AIUTUC). The Employees Provident Fund has more than 44 million subscribers.

The EPF trustees said the fund has been dipping often into the contingency fund to give subscribers a ''reasonable return'' for the past few years. The fund is reported to exhaust with the current pay-out.
EPF has already paid an 8.5 per cent on withdrawals and retiree payments in 2008-09, and that too for a higher amount than in earlier years.

The decision to retain the interest rate 8.5 per cent in the backdrop of the coming general elections is expected to be a severe drain on the economy at a time when the Reserve Bank of India is forcing a downward revision of interest rates – both lending and borrowing – in order to boost consumption.

Source: World Wide Web

Highest Bank Fixed Deposit rates for different time periods

The interest rates are peaking across different maturities and here is quick review of the highest interest rates across different time frames offered by various banks. 

Time Period Bank(s) Interest rate

15 - 29 days Barclays Bank  6.75%

30 - 45 days Barclays Bank, 

DBS Bank 7.25%

46-60 days Oriental Bank of 

Commerce 8.25%

61 - 90 days  Oriental Bank of

Commerce 8.25%

91 - 179 days ING Vysya Bank 10.00%

180 - 364 days State Bank of 

Hyderabad 10.25%

1 yr - 2 yrs DBS Bank 11.25%

2 yrs - 3 yrs CUB, KVB, LVB 11.00%

3 yrs - 5 yrs  Karnataka Bank 11.00%

In addition to the above, there are "Special Deposit Rates" offered by banks which are as follows:

Bank Rate Term (Days)

ICICI Bank 10.50% 890

City Union Bank 11.30% 1000

Federal Bank 10.00% 365

Standard Chartered 10.00% 401

ING Vysya Bank 10.50% 365

Tamilnad Mercantile

Bank 11.00% 1095

Please note that these special deposit rates are applicable only if you choose the specified term mentioned above. 

Make best use of this opportunity to lock in your fixed deposits componenet of your asset allocation. 

Time to lock into Fixed Deposits - Part III

After completing the first two parts on the attractive fixed deposit interest rates currently prevalent in the banking sector, we have been contacted by various people if they could committ into fixed deposits for 3 years for the entire corpus/savings they have.

We have also come across advertisements from banks over the last week or so where the interest have still gone up from the 10.50 - 11.00% bracket to above 11%. This is particularly very evident in the case of private sector banks and makes it all the more enticing.

The rates looks very tempting for lay investors. But at the same time, it is very important to note that the time-frame of the deposit should be decided by the funds requirements of the individuals. Just because a bank offers higher interest rates, the deposits should not be contracted for a longer time-frame. It should be aligned with the individual's funds requirement before the tenure of the fixed deposit is committed. In case you have surplus money which you may not require for a longer tenure, then it makes sense to lock into deposits at higher rates, but at the same time maintain your assset allocation matrix.

One should also remember that Fixed Deposits are only a portion of your investment portfolio and higher interest rates alone should not influence you to have a very high proportion of your investments in fixed deposits. When we take into account the inflation rate of around 8%, and the deposit rate of 11%, technically it means that you are able to get a real effective interest rate of only 3% or so pre-tax. Post-tax, the return would be much lower. Therefore, in order to grow your investments and build the corpus for meeting your future financial goals or retirement, you need to ensure that investments are also channeled to other investment avenues like equity, gold etc.,

The other point to remember is to spread your deposits across different banks with a maximum limit of Rs100,000/- to take advantage of the Deposit Insurance scheme. Though it involves more running between the banks, it may be prudent to do so.

Just for information purposes, few attractive interest rate options which has come up from private sector banks are:

1. City Union Bank is offering 11.30% on 1000 day deposit. Karur Vysya Bank is offering 11% on a 3 year deposit.
2. Standard Chartered Bank is offering 11.00% on 90 days short term deposit.
3. In Chennai, REPCO Bank Ltd., is offering 11.50% on 40 months deposit. But please note that REPCO Bank deposits doesnt come under Deposit Insurance Guarantee scheme.

Time to lock into fixed deposits? - Part II

India also started feeling the heat of global slow-down. Inflation ruling well above 12% has now slipped into single digits and it has been reported below 9% for the last week. The rupee continues to trade volatile against the USD and again slipping below the Rs49 mark yesterday. The Prime Minister is making statements to the effect that more pain is in the offing for India. Exports have gone down to a great extent both in manufacturing and service sector (IT) resulting in lesser inflow of foreign currency. FII sales in the stock markets are continuing and the demand for the greenback remains constant.

Coming back to the main question of interest rates in the econcomy, the auto manufacturers and real-estate developers are crying hoarse about the high interest rates which is affecting the demand for their products. Of course, the interest rates alone cant prop up an industry, but it is a definitely a critical factor. With the increasing cost of money, Indian industries have started delaying or jettisoning capacity expansion plans. Many projects could not achieve financial closure due to lack of funds in the market. Now the Government started stepping in through RBI by giving out signals of low interest rate regime. Now there is no threat of demand led inflation, Government is keen on reducing the interest rates in the economy. RBI, under a new head, D Subbarao, started using the monetary tools to bring down the rates to banks and financial institutions. It has aggressively cut the CRR rates by 3.5% over the last 2 months. It has reduced the reverse repo rates and opened up the window for lending to banks and mutual funds.

With the signals becoming clear that Government favouring a lower interest rate regime, the banks has started reducing the lending rates. Of course, the PSU Banks have taken the lead in this instance as they are more amenable to the Government's intervention in the interest rates. The measures taken by the RBI is expected to pump in more than 200,000 crores of Rupees into the system and it should relieve the current pressure on the credit. The interest rates may also start coming down over the next couple of months. Though term deposits are not as tax efficient as FMP's, it is still better to have a good percentage of your fixed income investments in the form of term deposits, as it gives the needed liquidity and the redemption terms are much more easier compared to FMP's. Therefore, I think it is one of the best times to committ funds to Fixed Deposits with banks to take advantage of the high interest rates offered by them.

State Bank of India offers 10.50% for 1000 days deposit and other private banks like Karur Vysya Bank, City Union Bank, Lakshmi Vilas Bank are offering 11.00% on term deposits for 400 days or more. State Bank's deposit scheme was very popular that it garnered more than Rs1000 crores on a daily basis during the first few days of this campaign. Remember, the deposits in the name of Senior Citizens fetches 0.50% more than the normal rates.

Enjoy this small window of high interest rates and commit your term deposits at attractive rates. Make hay while the sun shines!!!

Time to lock into fixed deposits? - Part I

Fixed deposits or time deposits were a long last financial instrument hardly used over the last 3-4 years thanks to continuous bull run in the stock markets. Persons who wants to keep money in Fixed deposits were looked down upon as risk-averse, conservative and naive investors. Low interest regime and inefficient tax structure also added to the woes of the investors in fixed deposits. Fixed deposits, as the preferred asset class, vanished from the investors radar.

Coupled with the recent turmoil in the global financial markets and erosion in value of stocks across the board and the high fixed deposit interest rates, fixed or term deposits have slowly gaining prominence again. Currently banks are offering attractive interest rates of 10.50% to 11.50% (for senior citizens) on retail fixed deposits.

If you analyse the reasons behind the high interest rates, you will understand that it is due to the tightening of the domestic money supply by RBI through various monetary policy measures like hiking the CRR rates and repo rates making it costly for banks to borrow and lend. RBI followed the dear money policy till couple of months ago due to the run-away demand led inflation. Suddenly in September, the global financial markets went through a very bad patch where many of the global investment banks disappeared from the scene and it led to sudden realisation of counter-party default risk among the financial community. Banks started hoarding cash instead of lending to customers and financial institutions thereby creating scarcity of deposits.

In that scenario, Indian banks and financial institutions which have lent money to various sectors like real-estate and others started facing defaults or delayed payments. The stock markets worldwide tumbled as the FII's started selling across the board and more particularly in emerging markets. FII's selling the stocks and taking the money out of the country resulted in heavy demand for the US Dollar. The Indian rupee depreciated sharply against the dollar breaching the Rs50 mark against the dollar before recovering to Rs48 against the dollar. The industrial production, exports and consumer demand started to slow-down across the world. Today many countries have seen negative growth in their economy. US, Japan and Europe have slipped into recession. What a change compared what was 6-9 months back. The reaction were swift and painful for most of the market particpants.

Part II of the article would be published tomorrow.

Get to know about Public Provident Funds(PPF)

Today we have a variety of fixed income instruments to consider. Bank fixed deposits are popular. There are several other alternatives including Infrastructure bonds, Post office Monthly Income Scheme (POMIS), Kisan Vikas Patra (KVP), National Savings Certificate (NSC), Provident Fund etc. We would like to profile a popular instrument – Public Provident Fund (PPF).

Overview:
PPF is a scheme started by the government of India in 1968. It encourages the public to save money for the long term. Generous tax breaks are available and it is currently the only instrument enjoying EEE benefits (tax exemption on the initial amount invested, interest which accumulates and the final amount which is withdrawn). It is also exempt from wealth tax.

1. The annual interest rate is reviewed on an annual basis. The current rate is 8%.
2. The minimum amount to be invested is Rs 500 per year and the maximum is Rs 70,000 per year.
3. There is a lock in period for fifteen years. Partial withdrawals are permitted after five years. It is also possible to take loans for the partial amount after one year.
4. After 15 years from the date of making the initial deposit, the depositor can opt for extension of the PPF account for a further period of 5 years.

PPFAdvantages:
1. Tax breaks - The product offers great post tax returns. To obtain 8% post tax returns, we need to invest in instruments which offer 11%+ pre tax returns (for those in the 30% tax slab). Risk free instruments offering such returns are not readily available.
2. Safety - Since the product has government backing, it has the highest safety.
3. Flexibility – We can invest what we can spare each year. It offers flexibility to investors to manage liquidity surplus/shortfalls. Suitable for those who have non-regular incomes as they can deposit part of their one-off income here, with a minimum amount of Rs500 every year.
4. Reach – Easy access for the product through the SBI office/post offices.
5 Nomination facility is available on PPF deposits.

Disadvantages:
1. Flexible returns – The annual interest rate varies depending on the government decision. In the last decade interest rates where as high as 12%, in line with the market rates.
2. Lock In- There is a lock in for fifteen years. While the withdrawal/loan provisions provide partial mitigation the funds are still locked in for fifteen years.
3. Documentation – Careful scrutiny of the pass book entries is required. Manual ledger entries are posted, which are prone to errors.
4. NRI’s cannot open a PPF account. Therefore, if you are planning to go on a long term trip which would make your residential status as "NRI", it is better to open an account before you leave the shores of India.

Points of Interest:
1. Minimum investments are required each year. While exceptions are possible it makes sense to invest at least the minimum amount.
2. Investing in the beginning of the month before 5th day is advisable to get higher interest.
3. While the individual limit is Rs 70,000 per year, it is possible to open separate PPF accounts for self, spouse and the HUF (more on HUF’s later)
4. Goal centric planning is possible – The lack of liquidity can be used to plan investments for a long term goal like children’s education.
5. NRI’s can continue to invest in PPF accounts opened prior to getting their residential status changed to NRI only on a "non-repatriation" basis.

Summary:
PPF is a great savings instrument for those in the highest tax bracket. It offers a combination of unmatched security, excellent returns and flexibility. It also inculcates a regular savings habit. If we park a portion of funds which are not required immediately then the lack of liquidity is a blessing as it allows the corpus to accumulate.

We strongly urge readers to open a PPF account at the soonest. While it does not have the glamour of equity or real estate investments, systematic savings in this risk free security will help us in the long run.