Opinion The basic points of interest
Will you have more options over savings account rates soon?<br>Banks can persuade savers to live with lower rates in return for better service and some innovation.
With inflation running at over 8 per cent for more than a year now,savers have been earning a negative rate of return from their bank deposits. Moreover,the interest rate paid out on savings accounts remains fixed at 3.5 per cent so any upside that customers may have had from rising interest rates has been lost. The Reserve Bank of India has been wanting,for some time now,to initiate a discussion on whether this rate should be freed; a paper on the subject is expected soon. While the central bank had observed,way back in April 2006,that in principle,deregulation of interest rates is essential for product innovation and price discovery in the long run,so far the savings rate has remained fixed.
Thats probably because banks have resisted a move to free rates,because it would add to their costs and hurt profitability. A senior banker recently pointed out that to break even on a savings account,the balance in that account should be somewhere between Rs 7,500 and Rs 10,000 at an interest rate of 3 per cent; if interest was increased to,say,5 per cent,the balance would have to be higher at
Rs 12,500. The banker went on to say that banks might be forced to altogether stop term lending because they wouldnt want to be vulnerable to an asset liability mismatch,or alm. An alm could arise since savings deposits would become more volatile with the rate varying with the demand and supply of money. Its possible that,in the near term,banks would be wary of loaning money for longer periods,since depositors could turn out to be fickle. Moreover,right now,money is in short supply.
Its also true that banks in India are hamstrung,partly because they need to mandatorily set aside some amount of cash and buy government bonds,which yield them little. There are also the compulsions of lending to the priority sector,to the extent of 40 per cent of total advances,a business that fetches relatively lower margins. And so if the rates on savings deposits rise,margins could come off. When the method of calculating the amount earned from savings deposits was changed in April last year,the cost of their deposits went up by 25 to 30 basis points,since savings deposits account for about a fourth of total deposits. However,most banks managed to cushion the impact by doing more business. A back-of-the-envelope calculation shows that a 100-basis point increase in the savings deposit rate could result in a 25-basis point increase in the cost of deposits,and a hit of 20 basis points on the banks margin,yields remaining constant.
But the regulator is right in that a free savings deposit rate would encourage innovation. After all,its essentially a transactions account,so its ease in transacting that customers are looking for. There are banks in the UK,for instance,which have a disproportionately large share of the savings deposit pool,but do not necessarily fork out the highest rates simply because they offer the customer a good product proposition. This is especially true for banks that follow a branch-based model. There are others,however,who attract customers with better rates,especially those whose models are built on the Internet-banking platform.
However,a good debit-card programme,with loyalty points,has been known to induce customers to settle for a lower rate on their savings deposits. Customers do not mind paying for good service and given the increasing affluence in India,this trend should play out here too. In other words,banks can persuade savers to live with lower rates in return for better service and some innovation. A large network of ATMs,for instance,is a big draw for customers in some Latin American markets like Brazil; a former Brazilian bank,Banco Itau,which later merged with Unibanco,had 23,000 ATMs in 2007. Over time,banks can segment their customer base,tailoring products to suit various needs. Therefore money could stick especially in rural areas.
In some senses,the savings rate has been deregulated,with some banks offering the auto-sweep product,in which money from a savings account is channelled into another account which offers a higher rate of interest. For their part,customers will have to learn to live with changing rates,and perhaps rates lower than 3.5 per cent in times when there is abundant money in the system. Also,banks will want to make up the higher costs by charging more for cheques,or for services like using ATMs and may even ask customers to leave more money lying around in their account. As the senior banker quoted above pointed out,there may be no free lunch for banks,but there wont be a free lunch for customers either.
The writer is Resident Editor,Mumbai,The Financial Express
shobhana.subramanian@expressindia.com
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