Have you ever earned an annual return of 6% on the money that you kept in your savings bank account? Such a return on your savings account can become a reality now, after RBI deregulated the interest rates offered on the savings bank account effective from October 25, 2011. As a result of this, some private sector banks have started offering such rates on savings accounts held with them. Does this prompt you to open an account with these banks? Or would you like to wait for your bank to follow the suit? But before you make up your mind for this, we put before you some facts and analysis of the interest rate deregulation and its likely impact on short term savings instruments such as liquid funds and savings bank account.
Deregulation of the interest rates on savings bank account
In the second quarter review of the monetary policy, RBI announced the deregulation of the savings bank account interest rates in October 2011. With this announcement the RBI sought to provide a sigh of relief to a common countryman who has been badly hit by the rising inflation. Interest rate on savings bank account remained unchanged since March 2003 until recently. The regulated interest rates did not move in concurrence with the changing market conditions.
The process of deregulation began in early days of liberalisation. To begin with, interest rates on the deposits with maturities ranging from 15 days to 1 year were deregulated with the ceiling of 8%. While banks enjoyed the complete freedom to individually fix rates on the term deposits offered by them, they maintained status quo on the savings bank account interest rates and offered the least fixed return on the immediate fund held by a common man in his savings account. Hence there was a need for a deregulation of interest rates on savings bank account which came as an extension to RBI’s commitment to financial sector reforms.
Need for deregulation
The prime motive behind the deregulation is to maintain the positive real interest rates in the economy. Deregulation will make the rate of interest on savings account flexible, market driven and in sync with the interest rate on other time deposits with banks with shorter maturities of upto 1 year. Furthermore, the large population living in rural and semi urban areas will benefit from this move. Unlike in metropolitan areas, where the savings bank account is held more for the day to day transaction purpose, in rural areas savings accounts is held primarily for saving and some even consider it as their investments. Hence deregulation is expected to make savings account more attractive in these areas and could have a positive impact on savings.
Impact on investors
The deregulation of interest rates on savings accounts has been a welcomed move for investors as they are likely to benefit from it. But there is a catch that the banks have the option to keep uniform interest rates at 4% p.a. for Rs 1 lakh and the banks are free to offer the deregulated rates on the balance above Rs 1 lakh held in the savings account. So you need to carefully read the fine print before opting. At present, liquid and liquid plus mutual funds are considered to be the better option to park one’s money for the immediate short term and still earn returns higher than those earned on the savings bank account. However, if the banks are ready to offer higher rates on the savings account, then the deregulation can suddenly make savings bank account a competitive product.
Impact on Banks
Banks too are likely to benefit by the deregulation. The chart given below gives an idea about the proportion of short term deposits with maturities up to one year in the total deposits of some major categories of the banks.
(Source: RBI and PersonalFN Research. Data as on March 31, 2011)
With deregulation of interest rates on savings account, banks will have another product i.e. savings bank account which can be offered as a short term saving product. Now, they would be able garner more deposits. Furthermore, in urban areas and in metros where the savings bank account is considered to be the entry point to the wallet of an investor, banks would compete among themselves to increase their investor base to be able to cross sell their liability products in future.
Consider this too...
There has been a furor about the deregulation as this is expected to work in favour of investors. However, investors should also keep in mind that deregulation of interest rate doesn’t always mean the interest rates offered will be higher. They can go lower too. A savings bank account holder has not faced such volatility in returns until now. Bearing this in mind, we believe it is imperative to understand how the interest rates are decided.
Repo and Reverse Repo have been the policy rates through which RBI manages the liquidity position in the economy. Movement of policy rates is considered as an indication of the macro economic objectives. Moreover, this is used as a reference rate for borrowing short term money, while this also leads to benchmarking the lending rates. Repo is a rate at which RBI lends money to banks, while Reverse Repo is a window where banks park their surplus with the RBI. Besides repo, banks borrow from various sources including call money market and CBLO market to even out their short term asset liability mismatches. Money Market mutual funds have access to some of these markets only as a lender and hence they are looked upon as an additional source of short term money. When RBI tightens the liquidity position in the economy by raising repo rates; cash strapped banks borrow from other sources including money market mutual funds by issuing instruments such as Certificate of Deposits (CDs) at a higher rate. Hence during such period your money market mutual fund can generate higher returns. With this the RBI achieves the objective of monetary transmission of tightening liquidity and curbing the demand for money. However when the interest rate on savings account remains deregulated, it obstructs the objective of monetary transmission as the money is always available at a fixed rate.
The chart below will help you understand how your returns from liquid and liquid plus schemes fluctuate depending on the objectives of broader monetary policy.
Movement of Repo and Reverse Repo
(Source: RBI and PersonalFN Research)
On an average, returns from liquid and liquid plus schemes drifted down from 8.7% in 2001-02 to 4.3% in 2004-05 to reflect the easing monetary policy. Performance of liquid funds as a category started picking up once again from 2005-06 before topping at 8% in 2008-09 as a result of monetary tightening. Most likely, liquid funds as a category are expected to end financial year 2011-12 with an enviable performance, thanks to the hawkish anti-inflationary stance adopted by the RBI.
However as stated earlier, the interest rate on savings bank account remained unchanged since March 2003. In other words, banks had access to cheap money at a fixed rate irrespective of the monetary policy objectives, which to an extent defeated the basic purpose of monetary actions.
(Source: ACE MF and PersonalFN Research; category average is the simple average of Year-on-Year returns generated by 40 mutual fund schemes falling in the category of money market mutual funds. NAV data is as on November 28, 2011)
With deregulation of interest rates there will be an improvement in the monetary transmission as now banks are no more mandated to pay at fixed rate on savings accounts. CASA Ratio of Banks
While we believe that the deregulation of the interest rate on savings bank account was much awaited and would impact the investors positively. However, the extent to which interest rates on such accounts could go up remains limited.
|Bank ||CASA Ratio (%) |
|State Bank of India ||47.6 |
|HDFC Bank ||47.3 |
|ICICI Bank ||42.1 |
|Punjab National Bank ||36.3 |
|Union Bank ||32.1 |
|IndusInd Bank ||27.7 |
|Kotak Mahindra Bank ||26.0 |
|Yes Bank ||11.0 |
(Source: Company Records and PersonalFN Research; CASA Ratio is as on September 30, 2011)
Table given above gives you an idea about the proportion of current accounts and savings accounts (CASA) in total deposits held by some banks. It is noteworthy that, the banks such as Yes Bank, IndusInd Bank and Kotak Mahindra Bank who have raised the interest rates on savings account lately have a lower proportion of CASA in the pie of total deposits with them. Hence in search of market share these banks are attracting new accounts by offering higher interest rates. On the other hand, large public sector banks and some old private sector banks that have a fairly strong CASA have not felt the need to change their interest rates on savings account. Moreover, if banks offer market determined rates on your savings accounts, then any monetary softening by RBI will result in dropping interest rates on these accounts. RBI has directed that all banks will have a freedom to determine interest rates on savings account on their own; subject to some conditions. One of these conditions is; each bank will have to offer a uniform interest rate on savings bank deposits up to Rs 1 lakh, irrespective of the amount in the account within this limit. And the second, for savings bank deposits of over Rs 1 lakh, a bank may provide differential rates of interest, if the bank chooses to do so. It will also have another condition of not discriminating in the matter of interest paid on such deposits, between one deposit and another of similar amount, accepted on the same date, at any of its offices".
Implication of these conditions is that while the banks are allowed to determine rates on their own, they will have to offer the same rate for the savings bank with a balance of Rs 10,000 and an account with a balance of Rs 99,999. It is important to note that, the interest rates have been deregulated and not the costs. It means banks will have to incur same fixed costs for giving you added services irrespective of your account balance over and above the minimum balance you need to maintain on quarterly basis. For example, when you open a savings account with a bank; you are also furnished with the services such as a free chequebook, a free passbook or an account statement. You are also allowed to use your ATM card any number of times at the same bank ATM and with a cap of 5 free transactions on other bank ATMs. The bank incurs fixed costs on each of these features of a savings bank account.
According to the data provided by RBI; per capita savings bank deposits by the end of March 2009 were about Rs 7,000. This in turn, means that the profitability of banks will be hit if they go aggressive on offering higher interest rates to attract new accounts as; on an average balance maintained in the savings bank account is low and costs are fixed and not deregulated.
Hence this will not enthuse all banks to offer high interest rates on the Savings bank account. And even if your bank is currently offering you high interest rates on your savings account, then it may not be always that high. And for that matter the returns that you earn on your savings account may not be able to beat the returns that of a liquid or a liquid plus funds which closely match the short term interest rates. And considering the post-tax returns that this category of funds offer; the returns of savings account may not be able to match these funds.
In a nutshell..
After considering all pros and cons of interest rate deregulation on savings bank account, we believe that investors would still be better off parking their short term surplus in liquid and liquid plus funds. Though not fixed, liquid and liquid plus funds have ability to offer relatively higher returns (as also seen in the past). They are the most suited avenues to generate money market linked returns. Some banks may initially offer higher interest rates to attract new accounts but if the costs start taking their toll on profitability; then banks may go unaggressive. The extra returns that you may get for short term, may not be worth; considering cumbersome process and paper work involved in opening a new bank account. Hence opening a new account with a bank only on the basis of higher interest rates on savings account wouldn’t be wise. Instead opting for a liquid or liquid plus fund based on your time horizon would be more sensible and convenient.
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