Deposit rate on savings accounts: To deregulate or not?

The interest rate on savings bank deposits in India has been at 3.5% since March 2003, before which it was at 4%).

In April 2010, the Reserve Bank of India (RBI) had changed the methodology of interest calculation on savings deposits to an average daily basis.

For banks, this has effectively increased the savings deposit cost by 50-100 basis points (bps) and overall deposit cost by 10-25 bps.

While interest calculation on average daily basis has led to higher earnings on savings deposits for deposit holders, the inflation-adjusted return continues to be negative.

Against the 3.5% rate on savings deposits, the average inflation rate in India has been around 5.3% in the last decade, around 5.5% over financial years 2005-10 and around 6.5% over fiscal 2008-11.

On multiple occasions, the RBI has expressed its intention to deregulate the savings bank deposit rate and is likely to float a discussion paper on this topic.

Alpesh Mehta and Abhishek Agarwal of brokerage Motilal Oswal collated bankers’ arguments in favour of and against such a move, and their views on the probable savings deposit rate in a deregulated environment. They also give their views on the possible impact on the banks they cover:

Arguments in favour of a regulated savings a/c rate.

> Cost of doing banking business in India is very high, considering the high reserve requirements - Cash reserve ratio (currently at 6% of deposits; zero yield) and statutory liquidity ratio (currently at 24%; low yield) - and high priority-sector lending requirement of 40% (low loan spreads and higher credit cost). Deregulation of savings deposit rates will impact profitability further.

> At a time when liquidity is very tight in the system, deregulation of savings deposit rate is likely to create a lot of uncertainty and a sharp increase in savings deposit rates. We believe in the near term this will prevent RBI to de-regulate saving deposit rates.

> Savings deposits are more gradual and provide long-term funding for banks. If the rates are linked to market rates, the behavioural pattern of savings deposits can change and create an asset-liability mismatch. On the asset side, funding is becoming long-term while liabilities are becoming of shorter duration, thus, leading to unfavourable asset liability equation.

> Banks provide a lot of free or subsidized services to savings bank account customers, the charges for which are not deregulated. In an interview, one of the banker mentioned that banks barely break even at a minimum deposit amount of Rs7,500 for savings accounts at the current regulated rate; if the rate increases, the minimum savings account deposit required to break even could be double the current amount.

> This is the last subsidy given to banks, which reduces cost of funds and indirectly helps to cover the costs for a lot of government initiatives like financial inclusion, etc.

> At a time when new banking licenses are to be given, deregulation of savings deposits rate will lead to ruthless competition and create uncertainty in the markets.

and those favouring deposit rate deregulation

> Inflation in India has averaged at 5%+ in the last five years; savings deposits effectively yield negative earnings for customers.

> The effective rate on savings accounts moved up due to change in calculation methodology to average daily basis in fical 2011. However, banks have been able to pass on the resultant higher costs to customers and protect margins. Similarly, with the base rate regime, any increase in cost of deposits automatically gets transmitted into higher lending rates, thus protecting margins.

> Deregulation of savings deposit rates will increase competition, resulting in increased emphasis on technology and customer service, which in turn will benefit customers.

Motilal Oswal’s views
> Initially, deregulation of savings deposits will lead to increase in the savings deposits rates in the system, led by competitive forces. However, in our view, there will not be a significant movement in savings deposits, as stickiness of these deposits will be a function of technology, liability franchise and most importantly reach in rural areas. Banks like SBI (with 60%+ current account savings account or Casa ratio in rural areas), PNB, HDFC Bank, Axis Bank and BoB will continue to have a higher share of savings account deposits in the system.

> Competition will intensify, with low-Casa banks trying to lure depositors by offering higher rates. In our view, eventually rates would settle down near to the three-six month term deposit rate in the system (depending upon the liquidity condition in the system).

> Another option for the RBI will be to keep the savings deposits rate regulated with increase in the savings deposits rate; for example 100 bps increase will lead to saving deposit rate to 4.5%.

> Based on our analysis, every 100 bps increase in savings deposit rate will result in 25 bps increase in cost of deposits and 20-22 bps margin compression, assuming no change in lending yields.