On the common man146;s credit

Yet, the one rate which banks are still not allowed to determine on their own, even after 15 years of an attempt to shift to market rates, is the interest on savings deposits. International experience suggests that fixing deposit rates is not the job of a banking regulator. Why then does the RBI persist with setting the savings deposit rate?

The decision appears to be shaped by three considerations: a desire to provide a public subsidy to banking, a desire to provide a public subsidy to PSU banks, and a fear of fraud.

First, how is this a public subsidy for banking?

Recently, the Indian Retirement, Earnings and Savings IRES database, released by PFRDA and ORG-AC Nielsen, shows that over 60 per cent of earners keep have savings accounts. This is unavoidable, because salary accounts are savings accounts and also because the common man can deposit or write cheques only by having savings accounts. As a result 24 per cent of the money held in bank deposits is held in savings accounts.

Now, banks have a monopoly on the payments system. There is no way to write cheques without banks earning a profit from the chequing account. Banks normally make a profit on the 8216;interest spread8217;, the difference between the interest paid out to depositors and that received from lenders. When the rate paid out to depositors is fixed at low levels, the spread is artificially increased and bank profits raised. Thus, when RBI forces low rates on savings accounts, it drives up the profits of banks. Customers get less than what they would have received. This involves a subsidy from customers to banks. In other words, artificially low rates on savings accounts are a subsidy for banks paid for by the common man.

Next, why does it imply a public subsidy for PSU banks?

PSU banks have a disproportionate strength on sourcing deposits from across the country. The growth of private banks has been choked by setting up entry barriers, and the growth of foreign banks has been choked by preventing them from opening branches. Hence, PSU banks have a large share of savings accounts. This gives RBI a reason to drive down interest rates on savings accounts: it is a state-sponsored subsidy in favour of PSU banks, paid for by households.

In recent months non-food credit has been growing at 30 per cent, a growth rate which is faster than the growth of deposits. But banks are not allowed to offer higher interest rates on savings deposits to attract people to deposit money with them. Why? Perhaps because private banks may offer higher interest rates and attract away customers from public sector banks!

Forcing rates to be the same across banks is a way of ensuring that even if a bank is more efficient, it is not allowed to offer a better price to customers. Already, the growth of savings and current account deposits with private banks has been faster than that with public sector banks in the last decade. If, in addition to better services, these banks are also allowed to offer better rates, customers would move. Fixing interest rates is, therefore, a way to reduce the competition for PSU banks.

There is no reason why PSU banks should be molly-coddled by the RBI, just as the airline industry should not be distorted to protect IA or AI, and the telecom industry should not be distorted to protect BSNL and MTNL. The job of the regulator is to ensure competition in the economy, not to protect the interests of PSUs.

Is fear of fraud a good reason to administer the savings deposit rate?

When regulation and supervision of banks is weak, the managers of a bank will be tempted to setup 8220;ponzi schemes8221;, in which banks use new deposits to pay off high interest to old ones. Such schemes, such as the one run by Charles Ponzi in the early 20th century, are bound to collapse one day, like his did after an investigation into his account books. RBI8217;s response to this danger is not better supervision and monitoring, but blocking higher interest rates paid by banks. Fraud is surely a problem and needs to be blocked, but it is wrong to make customers pay for the regulator8217;s weakness.

Moreover, this argument is flawed because banks are free to determine interest rates on fixed deposits. If a bank wanted to set up a ponzi scheme, and suck in deposits using high interest rates, it could do so using fixed deposits. There is no point in distorting savings accounts in order to address a danger that is present in any case.

In addition, India has numerous poorly regulated cooperative banks, chit funds, NBFCs, company deposits, etc running ponzi schemes, where high interest rates are offered to suck in deposits. Consumers know that there are important risks in signing up for an attractive rate with a chit fund. But the appeal of this high-risk, high-reward gamble is accentuated by the low interest rates paid by savings accounts. To the extent that the interest rate on savings accounts was set on the market, the appeal of these schemes would come down.

RBI should aspire to achieve the quality of a central bank of a modern market economy. Banking regulators in modern market economies no longer fix interest rates. It is time for RBI to step out of the 1970s world view, and let banks choose interest rates for their savings accounts.