What is DEREGULATION ? It means it will not be under control of RBIanymore. The interest rates will differ foreach bank. The banks will decide theinterest rates based on their financialcondition and other factors. Thederegulation puts more competitionamong the banks to attract more savingsbank account holders.
As a part of financial sector reforms, the Reserve Bank has deregulated interest rates on deposits, other than savings bank deposits. The interest rate on savings bank deposits has remained unchanged at 3.5 per cent per annum since March 1, 2003.
An attempt was made to deal withpros and cons of deregulating savingsdeposit interest rate and take on boardthe suggestions of variousstakeholders for either maintaining thestatus quo or deregulating the savingdeposit interest rate.
HISTORY BEHINDDEREGULATION India pursued financial sector reforms as a part of structural reforms initiated in the early 1990s. A major component of the financial sector reform process was deregulation of a complex structure of deposit and lending interest rates. The administered interest rate structure proved to be inefficient. It, therefore, became necessary to reform the interest rate structure.
What is the need of Deregulation?What are the factors that intended deregulation to occur?
Deregulation is needed to : Strengthen the competitive forces, Improve allocative efficiency of resources, Strengthen the transmission of monetary policy, Product innovation, Price discovery.
A few categories of interest rates that continued to be regulated on the lending side were small loans up to 2 lakh and rupee export credit, and on the deposit side, the savings bank deposit interest rate. The rates on small loans up to 2 lakh and rupee export credit were deregulated in July 2010, when the Reserve Bank replaced the Benchmark Prime Lending Rate (BPLR) system with the Base Rate system. With this, all rupee lending rates were deregulated. On the deposit side, the only interest rate that continues to be regulated was the savings deposit interest rate .
The Annual Policy Statement of 2002-03 had weighed the option of deregulation of interest rate on savings bank deposit accounts but the time was not considered opportune considering that a large portion of such deposits was held by households in semi-urban and rural areas. It was, however, argued that deregulation would facilitate better asset-liability management for banks and competitive pricing to benefit the holders of savings accounts.
The issue was again revisited in the Annual Policy Statement for the year 2006-07. In this context, the Indian Banks’ Association (IBA) while making out a case for deregulation of savings bank deposit rates in the long run, suggested for status quo in 2006. In pursuance of the announcement made in the Annual Policy Statement for the year 2009-10, the Reserve Bank advised scheduled commercial banks to pay interest on savings bank accounts on a daily product basis with effect from April 1, 2010.
Prior to the introduction of a daily product method, the interest on savings deposit account was calculated based on the minimum balance maintained in the account between the 10th day and the last day of each calendar month and credited to the depositor’s account only when the interest due was at least 1/- or more. After the change, the effective interest rate on savings bank deposits increased, thereby benefitting the depositors.
The concept of savings account•A savings deposit is a hybrid product which combines thefeatures of both a current account and a term deposit account.•While a current account is primarily meant for transactionpurposes and is maintained by companies, public enterprisesand business firms for meeting their day-to-day requirement offunds, savings accounts are maintained for both transaction andsavings purposes mostly by individuals and households.•A savings account being a hybrid product provides theconvenience of easy withdrawals, writing/collection of chequesand other payment facilities as well as an avenue for parkingshort-term funds which earn interest.•The maintenance of savings bank deposit accounts, however,entails transaction costs. Where as, a term deposit doesntinvolve transaction cost for banks.
• The average annual growth of savings deposits, which decelerated in the1990s compared with that of the 1980s, accelerated sharply in the decade ofthe 2000s.• In this decade, the average growth rate of savings deposits exceeded thatof demand and term deposits, notwithstanding the growth in term depositsoutpacing that of savings deposits during 2005-10.• The Credit Policy of May 27, 1977 for the first time drew a distinctionwithin savings deposit accounts in that a part was considered as functionallytransactions-oriented vis-à-vis the remaining part that had features akin tosavings.• Accordingly, the Reserve Bank, with effect from July 1, 1977, fixed theinterest rate on savings deposits with cheque facilities, considered astransactions-oriented accounts, at 3.0 per cent and the interest rate onsavings deposits without cheque facilities, considered as pure savingsaccounts, at 5.0 per cent.• However, the Credit Policy of March 2, 1978 merged these two accountsinto a single savings account, on account of many depositors openingmultiple accounts.
History of Savings Bank Interest Rates March 2, 1978 – Interest rate @ 4.5 % p.a April 24, 1992 – Interest rate @ 6.0 % p.a. March 2003 – Interest rate @ 3.5 % Presently 4 @ p .a.
Ownership Pattern of Savings Deposits The data on the ownership pattern of savings deposits during 1998-2009 reveals that savings deposits are predominantly held by the household sector. (per cent) Sector 1998 2009 1 2 3 I. Household Sector 84.8 83.6 II. Government Sector 8.4 9.1 of which: 3.3 5.3 State Government 1.9 1.7 Local Authorities 1.7 1.2 Public Sector Corporations and Companies III. Foreign Sector 5.3 6.0 IV. Private Corporate Sector 0.2 0.4 (Non-financial) V. Financial sector 1.4 0.8 VI. Total 100 100
Costs incurred by a bank inmaintaining the savings account Interest payments to account holders Computer costs Staff salary Passbook costs Printing charges Intimation costs for inoperative accounts Costs incurred in case the customer withdraws a large sum from the bank immediately.
Two major changes•Change in the interest calculation methodologyThe interest calculation methodology has beenshifted from minimum balance between 10th and lastday to the daily product basis with effect from 1stApril, 2010.•Deregulation of Savings account interest ratesRecently, the savings deposit rate has alsobeen increased by 50 basis points to 4%. In simplewords, deregulation is removing RBI’s control overthe prevalent interest rates for banks’ savingsaccounts.
How savings account interest is calculated?•Earlier, interest was calculated on the lowest amount available in savingsaccount from 10th to the end of month. The disadvantage is that if you have alow balance on any of these days, you will get interest on that amount only.For example:If the account shows the following balance for the month of February 2010: Interest will be received on 1,000/- rupees, which is the lowest balance available in the account. According to the new circular from RBI, banks have to calculate the interest on a daily product basis and this must be implemented from April 1, 2010. This way savings account holders will not lose interest for even a rupee.
DEREGULATION -Effective 25 October, 2011RBI has explicitly sent notification to the banks for changing theirsavings bank interest rates. The banks are now free to set their interestrates for their customers.Conditions• Uniform rate to all customers having savings account balance of up toRs. 1 lakh. For balances above Rs. 1 lakh, banks are free to chooseinterest rate bands.•Banks can create a tier structure for interest rates on balances of overRs. 1 lakh, so they could offer 5% for balances between Rs. 1 lakh – 5lakh, and 6% for balances over Rs. 6 lakhs and so on.The way the interest is calculated should remain the same – that is thedaily balance method that’s currently followed and banks shouldn’t getback to their gimmicky ways of taking the minimum balance in a monthetc.
Important aspects regarding deregulation•New banks can now offer a higher interest rate to persuade customers to moveaway from their old banks. But as can be visualized, the interest rates paid by allbanks on their savings accounts will rise. This will adversely affect banks’profitability.•The banks will compete with each other on savings account interest ratestherefore, a customer will benefit in the form of higher interest rates.•When banks had to pay just 3.5% as interest, they were able to give freechequebooks, allow free cash withdrawals and charge a nominal fee for otherservices.•Ifbanks have to remain profitable, they have two options. First, increase thelending rates to ensure the same profitability in spite of paying a higher savingsaccount rate. Second, cut costs related to savings accounts.•As can be seen, banks have increased interest rates to get more savingsaccounts. But at the same time, they will be forced to remain competitive by movessuch as an increase in the minimum balance requirements, having a tiered interestrate structure (wherein better rates are offered to customers with a larger balance),imposing a charge for issue of chequebooks and so on.
Few Banks join the raceInitially, the banks which have hiked the interest rate are:•Yes Bank•Kotak Mahindra Bank•IndusInd BankReason • Fewer savings accounts Relatively new • Do not have a strong players retail portfolio
What prompted Yes Bank?The prompt move to inject deposit hike comes on the back of its : - lowest share of savings bank deposits to total deposits in the whole industry (3% CASA deposits) - Hardly 1% or 2% of the private lender’s deposits come from Savings deposit funds.Thus, this private bank always had more room to capitalize on free interest rateregime unveiled by the country’s apex banker.
SBI says no immediate hike in saving deposit ratesOn the other hand, India’s leading state-owned bank SBI has not yethiked the savings deposit rates.State Bank of India: The rate will be increased by upto 1.25%, thusmaking it 5.25%. The decision is not yet taken.• In contrast to Yes Bank, SBI already has 34% of its total deposits insavings bank account – which is amongst the highest industry ratio interms of holding low cost funds to total deposits. Thus, SBI is seen in nohurry to introduce the deposit hike in very near-term.•The banks which have raised savings deposit rates lack reach.• The bank is sitting on a huge deposit base and has no concernregarding cost of deposits going up due to the deregulation.•The total deposits in SBIs savings accounts are to the tune of nearly Rs3.5 lakh crore, and a hike of one per cent in interest would mean that itwould cost the bank Rs 3,500 crore, which will have to be passed on tothe customers
• Lakshmi Vilas Bank can decide to give its savings account holders 5%while ICICI may decide to give its account holders 4%.• Vijaya Bank - Savings Bank - 4.00 % p.a (Effective from 03 - MAY 2011)•Sincethe large banks like SBI, ICICI Bank, Punjab National Bank (PNB)and HDFC Bank have not made any changes in their interest rates, othersmaller banks have not felt the need to change the status quo.•The countrys largest urban cooperative Saraswati Bank announced onNovember 29 that it would offer 6% interest on savings deposits which willbe payable every quarter.•Axisand Bank of Baroda offers Savings Account Deposit Interest Rate @4% (for all amounts).
Banker’s Point of view•As an impact of the soaring inflation, the real rate ofinterest on savings is negative and hence deregulationseems inevitable. However, banks hold a mixed opinionon the same.•While the state-owned banks are more in favour of theregulated savings deposit rate, the private banks aremostly in favour of deregulation.•Many banks affirm that if interest rates are to bederegulated then RBI should also deregulate themaintenance charges.
Effect of Deregulation Competition Increase in Interest rate Reduction in Net InterestMargin if not balanced by increase in lending rates
•Large Public sector banks like Punjab National Bank areexamining ways how to offset the increase in SavingsBank Account.•The bank has SB deposits aggregating Rs 1 lakh crore. Increase in Increase of Rs. SB interest 1,000 crore in rate by 1% interest payments
International Experience Deregulation of savings bank deposit accounts in select developed and emerging market countries. Interest rates on savings account in developed countries such as Canada, Japan, Australia, New Zealand, UK, and USA are all deregulated and determined by the commercial banks themselves on the basis of market interest rates
Many countries in Asia experimented with interest rate deregulation to support overall development and growth policies Interest rates were fully deregulated in Singapore in the mid-1970s, and in the Philippines, Indonesia and Sri Lanka in the early 1980s.
Malaysia, Thailand and the Republic of Korea engaged in a gradual deregulation process, characterised by more frequent adjustments and the removal of some ceilings Interest rates on bank deposits in Hong Kong, which were regulated by a set of interest rate rules (IRRs) issued by the Hong Kong Association of Banks (HKAB), were deregulated in phases by July 2001
In response to the deregulation, a number of banks launched new products such as combined savings and checking accounts and Hong Kong inter-bank offered rate (HIBOR) linked savings products Some also revised fees and charges and minimum balance requirements, and introduced tiered structures of interest rates
Based on an examination of the effects of interest rate regulation and subsequent deregulation on the efficacy of monetary policy and rigidity of retail bank deposit rates in Hong Kong, Chong (2010) found that interest rate deregulation had increased the efficacy of monetary policy by improving the correlation between retail bank deposit rates and market interest rates and increasing the degree of long-term pass- through for retail bank deposit rates
Rates on savings accounts in China are regulated by the Peoples’ Bank of China, which specifies ceiling interest rates on these accounts DBS Bank, Singapore provides a facility that combines the current account and savings account, but has a higher minimum balance to be maintained and the customer is charged
In countries in which financial sector reforms also included interest rate deregulation, the action was primarily taken because real rates were negative, and were being propelled by inflationary pressures
On the whole, cross-country experience shows that in most countries, interest rates on savings bank accounts have been deregulated and are now fixed by commercial banks based on the market interest rates
Pros and Cons ofDeregulation ofSaving AccountInterest Rate
Merits Will enhance the attractiveness of Saving Deposits. Regulation of interest rates imparts rigidity to the instrument/product as rates are either not changed in response to changing market conditions or changed slowly. This adversely affects the attractiveness of a product/instrument. Will improve transmission of monetary policy. 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.
Co -relation among various ratesInterest Rate Co relation CoefficientTerm Deposit Rate and Monetary .82Policy ratesSaving Deposit Rate and Monetary .18Policy Rates
Will lead to product innovation Savings deposits constitute about 22 per cent of total deposits. However, owing to regulation of interest rate, there is hardly any competition in this segment with both banks and depositors acting passively. This has inhibited product innovations. May lead to financial inclusion Increase in SA Interest rate would encourage people in rural and semi urban areas to park more funds in Saving Account which can actually fulfill India’s objective of Financial Inclusion.
Demerits Possibility of unhealthy competition A major attraction of savings deposits for banks is that it offers a low cost source of funds. If deregulation happens, it will push up the cost of funds of the banking sector. This, if passed on to the borrower, will raise the cost of borrowings and if not, it will affect the interest margins and profitability of the banking sector.
Share of CASA Average cost of deposits(Per cent)Public Sector Banks1-30% 6.1930-40% 5.8340-50% 5.4150% and above NAPrivate Sector Banks1-30% 6.6630-40% 5.5940-50% 5.1850% and above 4.51
Risk of Asset-Liability mismatches Although savings bank deposits represent short- term savings and withdrawable on demand, a large part of savings deposits is treated as ‘core’ deposits, which together with term deposits have been used by banks to increase their exposure to long-term loans, including infrastructure loans. deregulation may have the potential to create asset liability mismatches as some banks with large dependence on savings deposits for financing long-term assets may lose savings deposits to some other banks.
Year Term Deposits of more Term Loans/ Total than 3 years/Total Term advances Deposits2001 31.7 36.72002 28.7 42.22003 23.9 44.52004 27.8 49.02005 26.5 54.12006 24.5 55.92007 22.6 57.72008 23.1 58.02009 20.2 57.1
Share of CASA Average Term Loans/ Total deposits ( %)20-30% 5230-40% 6040-50 % 64
Could adversely effect Small savers/Pensioners There could be occasions, especially when the liquidity is in surplus, when savings deposit interest rates may decline even below the present level. This will affect the income flow to small savers/pensioners. Possibility of introduction of complex Saving Products It is also possible that banks introduce some complex products, which may not be so easily understood by savers .
Things to consider while opening a saving account
Things to consider while openinga saving account Savings account interest rate Branch network Fixed deposit rate
Things to consider while openinga saving account Investment advisory services Call centre experiences Net banking
Things to consider while openinga saving account ATM facility Locker facility Charges on variousservices
Public SectorBanks VS Privatesector Banks………(what lies ahead)
What is CASA ? ? Casa is basically the current and savings account deposits. Casa ratio is the share of current and savings account deposits to the total deposits of the bank. What is NIM ? ? NIM is essentially the difference between the total interest earned and total interest paid as a percentage of total assets and it shows the average margin a bank makes by borrowing and lending funds.
Points in favour of Private SectorBanks( if they increase SA ROI)... Increase in ROI would increase CASA Increase in CASA would increase deposits available for Term Loans Low cost of funds BUT All this at the cost of decrease in NIM Still Pros > Cons
Arguments against Public Sector Banks If they increase ROI Huge impact on NIM HDFC Bank has the highest share of Casa to total deposits at 52%, followed by the State Bank of India at 48% and ICICI Bank at 45%. If they don’t increase ROI CASA might shift from Public Sector Banks to Private Sector Banks Asset Liability Mismatches Increase in cost of funds
Arguments in favor of PublicSector Banks Mathematical Analysis Let’s calculate how much a 1.5% hike in savings rate means for a Rs 50,000 balance. In a year it amounts to an additional interest of Rs 750, or Rs 63 more per month, before tax. If your bank hikes savings rate by 100 bps compared with 200 bps by another bank, and you switch banks, then you stand to earn only R83 more every month for a bank balance of Rs 1 lakh. Safety factors
Other Alternatives Liquid MFs Liquid and ultra short-term funds have offered about 7-7.5% return per annum. Further, dividends in liquid funds and ultra short-term funds are taxed at 27% and 13.5% respectively, compared with 30.9% at which your savings bank account interest is taxed. Sweep in Accounts A bank account that automatically transfers amounts that exceed a certain level into a higher interest earning investment option at the close of each business day. Commonly, the excess cash is swept into money market funds
Saving Bank Account ( Money earns 4-6% Auto Sweep Bank Account ROI) Auto- Sweep Acc ROI Saving Acc ROI
Why settle for 6% on your savingsaccount when short-term FDs cangive 8-8.5%?
CONCLUSION The big players of the banking industry would still continue to rule. The cost of funds for many banks dependent on CASA deposits will rise, but the depositors will now get a more market-determined rates attuned to inflation and policy rates. Banks will now have to focus more on managing asset-liability mismatches and fund management rather than rely on low cost deposits. The NIMs of banks will also shrink and increasing focus will be on efficiently managing cost of operations. In effect, this will bring better efficiency in the banking system.