Savings rate rises, deregulation looms. Will you be loyal to your bank?

The Reserve Bank of India (RBI), as a first step to deregulate saving deposit rates, increased the interest rate to be paid on saving deposit from 3.5% to 4% on Tuesday.  Last month, the RBI released its discussion paper on deregulation of interest rate on saving deposits and sought feedback from the public.

Deposits in saving account constitute a huge 13% of the overall savings in financial assets for individuals. Further it also constitutes 22% of the total deposits of scheduled commercial banks. Thus any change in interest rate on saving deposits has a major impact both on the bank as well as on the depositor.

What will deregulation of interest rate mean to you?
Post deregulation, the banks will be free to fix the interest rates on saving deposits.  It will be decided by the market interest rates which in turn will be decided by the overall liquidity situation in the market and that of the bank.

Though the market interest rates have fluctuated over a period of time, interest rates on saving bank deposits have remained unchanged at 3.5 % pa since March 1, 2003.
The chart, taken from the RBI discussion paper, clearly depicts that except for a brief period in 2005 and in 2009-10, over last six years, the interest rate on saving bank deposits was less as compared with interest rates on term deposits of one month and above. Considering that 22% of the bank funds come from these deposits, banks benefited by this low interest rate.

Amount lying in savings account can be bifurcated into (a) amount kept for transaction purpose and (b) saving component.  90% of the amount in savings deposit is held for saving purposes. Even though the tenure of such savings is not easily determinable, it can be safely assumed that it can be more than 1 - 1.5 months on an average and warrants more interest rate.

Thus, once the deregulation takes place, one can expect overall increase in saving deposit rate. However, there might be period during which overall liquidity situation is in surplus and banks are able to procure cheaper funds. During such periods, saving deposit rate may get reduced and can even be lower than 4% p a. The probability of occurrence of such instances will be rare and for short period of time frame.

Things you should be alert of post deregulation
Once deregulation is in effect, banks will need to compete and scramble for saving deposits.  In such competitive landscape, banks will introduce customised and complex products to attract customers.  It can be a combination of savings and current account, or combination of savings and fixed deposits.  It may offer layered interest rates where interest rate depends on the quantum of funds lying in savings account, with higher the amount, higher the rate.  One needs to see the suitability of such products before opting for any of them.  One thing for sure is that the ‘boring’ saving account will become more ‘exotic’ in terms of offerings and complexity.  Be prepared for deluge of saving account products.

Further, since higher rate will impact the profitability of banks, you need to be ready to pay for services you avail from your bank.  Thus bank may start charging you, in case not already charging, or increase the charge for withdrawals in excess of maximum permitted within a specified period.  They may charge you to issue cheque books, charge you in case you visit their branches or charge you for making a phone call and speaking with their customer care representatives!!  All this will lead to increase in bank charges.  Thus you need to consider the increased rate benefit and corresponding increase in charges before opting for a particular bank.

Will it reduce your loyalty to a particular bank?
Saving deposit accounts are not easily ‘transferable’ i.e. in case you are not happy with a particular bank due to its low interest rate offering, you cannot transfer your account to another bank immediately.  Though technically one can freely and easily open and close a savings account, however, in real life, it is difficult to do so, since the savings account is linked with other financial products.  You give your savings account number to your employer for direct credit of salary, your savings account is linked with your mutual fund investments and demat account, your home loan and car loan EMI is debited to the savings account, you have given your savings account number to income tax department for refund and the list goes on.

Thus, savings bank account is closely linked with one’s financial products and change in savings bank account will not be an easy decision. Thus, before you leap for a bank that gives you a carrot of high interest rates on your savings account, do check for the sustainability of higher interest rates (it can be a short term marketing gimmick to attract customers) and also check for the charges bank will be levying.

Vishal Shah is a chartered accountant. He blogs at http://bachhat.blogspot.com