SB deposit rate: RBI must review its policy

The Reserve Bank of India (RBI) freed fixed deposit rates 15 years ago and banks have shown great maturity and judgment in determining their individual bank’s structure of fixed deposit rates. There has not been any deposit interest rate war among banks, although banks have offered different rates taking into account the maturity structure of their deposits and their liquidity position.

The Savings Bank Deposit Interest Rate continues to be fixed by the RBI. Despite periods of surplus funds or tight liquidity in the banking system, the Savings Bank Deposit Interest Rate has been unchanged, rock-like for the past eight years at 3.5 per cent per annum.

From time to time, the RBI has mooted the issue of freeing the Savings Bank Deposit Rate, but on each occasion the RBI has backed off. In October 2010, the RBI indicated that it would present a Discussion Paper on deregulation of the Savings Bank Deposit Rate, but such a Discussion Paper has, not as yet, been put out in the public domain.

Savings Bank Deposits account for about 25 per cent of total deposits. The proportion of these deposits is generally higher for public sector banks and new private sector banks. The public sector banks have vociferously argued against the freeing of the Saving Bank Deposit Rate. These banks fear that freeing this rate will make Savings Bank deposits volatile. It is claimed that banks provide free or heavily subsidized services to Savings Bank accounts. Some banks opposed to freeing the Savings Bank Deposit Rate raise the bogey that if this rate is raised or freed it will work against the objective of attaining financial inclusion (i. e. bringing in more people into the organized banking sector).

Again, it is argued that many depositors use Savings Bank Accounts like Current Accounts and moreover, these depositors can easily switch from Savings Bank Accounts to Fixed Deposits. It is argued that if the Savings Bank rate is freed then banks would have the freedom to offer higher rates to larger deposits and lower rates to smaller deposits. This will work against the basic objective of financial inclusion.

It bears mentioning that depositor loyalty is ferociously strong and depositors do not readily shift from one bank to another; this is borne out by the experience of freeing fixed deposit rates. In the case of Savings Bank Accounts one must recognize who is subsidizing whom. As the late Mr. M. R. Pai, the indefatigable consumer activist, said banks are living off the ignorance of depositors.

Once depositors fully understand their rights banks will be in trouble. The larger Savings Bank depositors use this facility as a Current Account and use techniques such as Sweeping Accounts or Multiple Fixed Deposits options under which deposits are moved out of Savings Bank Accounts to Fixed Deposits and back to Savings Bank Accounts without any significant loss of interest in fact these facilities enable depositors to earn much more than on the Savings Bank Accounts.

The bulk of Savings Bank Deposit Accounts are small but very stable and many of these depositors do not use cheque book facilities. Under the present system of an unchanged Savings Bank Deposit Rate, larger depositors enjoy many facilities while the small depositors are inflicted by artificially depressed rates of interest.

It is not advocated here that that there should be a one- shot deregulation of the present interest rate of 3.5 per cent fixed by the RBI. What is suggested is that the RBI should undertake a series of “baby steps”, which, after all, is the present theology of the RBI. Debits to Savings Bank Accounts should be restricted to 52 per year (this was the practice till the 1960s) and any excess debits should be subject to a hefty charge. Again, those depositors opting for cheque facilities should be subject to steep charges (some banks already follow such a practice).

Interest on Savings Bank Accounts should be given only on balances up to Rs 2 lakh on any one day. This will ensure that large depositors with frequent transactions will prefer to maintain Current Accounts or Fixed Deposits.

It should be clearly stipulated that a bank cannot discriminate among Savings Bank Accounts irrespective of the size of the deposit and the rate of interest payable should be uniform for all customers.

Subject to these provisos the Savings Bank Deposit Rate could be gradually freed. In the first stage, the present fixed rate of 3.5 per cent should be the floor and should not exceed 4.5 per cent. Banks would need to be cautioned that the rate offered by them on Savings Bank Accounts should not erode their margins and profitability. Some banks will find it to their advantage to offer higher rates on Savings Bank Accounts and refrain from mobilizing fixed deposits at relatively high rates while other banks would not find it remunerative to raise the Savings Bank Rate above the floor.

The RBI may find that there could be risks in even a limited deregulation of the Savings Bank interest rate; in such a situation it would be incumbent on the RBI to periodically increase or decrease the Savings Bank interest rate depending on the overall stance of monetary policy. At present, there would be a strong case for raising the Savings Deposit Rate. Resorting to a frozen rate, as the RBI has done for eight years, is not reflective of a responsible interest rate policy. The present Savings Bank interest rate is clearly against small depositors and is not in consonance with financial inclusion. In fact the ‘ No Frills’ account holders, who are being brought into the organized banking system with minimal facilities, are being punished by the rigid Savings Bank Deposit Rate.

The RBI has to recognize, that in the area of the Savings Bank Deposit Rate, it has to lead, follow or get out of the way; the present policy of rejecting all three options is untenable.