In most countries, interest rates on savings bank accounts are set by commercial banks based on market conditions

Freeing savings bank rate is a complex issue in India. The Reserve Bank of India (RBI) recently launched a debate on this issue by presenting a discussion paper prior to its Annual Monetary Policy for 2011-12.

While announcing the policy, the RBI has also raised the savings bank rate from 3.5 per cent fixed in 2003 to 4 per cent. The spread between savings deposit and term deposit rates has widened significantly in recent times. This was why the RBI raised the savings bank rate, while a decision on freeing these rates was pending before the central bank for a final decision.

“We want to be sure that it contributes to financial inclusion. So that it does not militate against financial inclusion,” said the RBI Governor, D. Subbarao, in his post-policy press conference, referring to the deregulation of savings bank rate.

On raising the savings rate his deputy Subir Gokarn said that this rate had been at 3.5 per cent since 2003 all other rates have been deregulated, rates have moved up and down in the last eight years but this one had not and so as part of the overall adjustment, deregulation was still a debated proposition whether “we should let it go or not”. But given the differential that had emerged between this rate and all the other rates, particularly in this upward cycle, the RBI thought that an adjustment was necessary.

With regard to all other interest rates, Dr. Subbarao has pointed out that “We moved away from regulation”. Almost all interest rates, except the one on savings bank and NRI deposits which are administered as of now, are deregulated. So, “we believe that that is the way to move forward but again I want to say that we are open-minded and we would certainly respect and are being open to all the feedback that we get”.

Now banks have complete freedom in fixing their domestic deposit rates, except interest rate on savings deposits, which continues to be regulated. In pursuance of the announcement made in the Annual Policy Statement for 2009-10, the Reserve Bank advised scheduled commercial banks to pay interest on savings bank accounts on a daily product basis with effect from April 1, 2010.

Prior to the introduction of a daily product method, interest on savings deposit account was calculated based on the minimum balance maintained in the account between the 10th day and the last day of each calendar month and credited to the depositor's account only when the interest due was at least Re.1 or more. After this change, the effective interest rate on savings bank deposits increased, benefiting the depositors.

Savings accounts are maintained for both transaction and savings purposes mostly by individuals and households. A savings account, being a hybrid product, provides the convenience of easy withdrawals, writing/collection of cheques and other payment facilities as well as an avenue for parking short-term funds which earn interest. The maintenance of savings bank deposit accounts, however, entails transaction costs. In fact, a term deposit doesn't involve transaction cost for banks.

Savings deposits are an important component of bank deposits. The average annual growth of savings deposits, which decelerated in the 1990s compared with that of the 1980s, accelerated sharply in the decade of the 2000s. In this decade, the average growth rate of savings deposits exceeded that of demand and term deposits, notwithstanding the growth in term deposits outpacing that of savings deposits during 2005-10. The RBI had raised several questions on this issue. Should savings deposit interest rate be deregulated at this point of time? Should savings deposit interest rate be deregulated completely or in a phased manner, subject to a minimum floor for some time? How can the concerns with regard to savers (senior citizens, pensioners, small savers, particularly in rural and semi-urban areas) be addressed in case savings deposit interest rate is deregulated? How serious are concerns relating to a possible intense competition among banks and asset-liability mismatches if savings deposit interest rate is deregulated? Should higher interest rate be paid on savings deposits without a cheque book facility?

Global experience

In sum, deregulation of savings deposit interest rates has both pros and cons. The RBI's view, as reflected in the discussion paper, was that savings deposit interest rate could not be regulated for all times to come when all other interest rates have already been deregulated as it created distortions in the system. International experience suggests, according to the RBI, that in most countries, interest rates on savings bank accounts are set by the commercial banks based on market interest rates.

Most countries in Asia experimented with interest rate deregulation to support overall development and growth policies. These resulted in positive real interest rates, which in turn contributed to an increase in financial savings.

Further the RBI argues that deregulation of savings bank deposit interest rate also led to product innovations.

The flowery points of the RBI are likely to give a push for a de-regulation. However, unlike many other countries in Asia as well as other parts of the world, the Indian situation is different. A large number of people in India are from the rural background with less saving.

The urban poor, migrated from the remote rural areas of the country too are having small savings.

The urban labourers send their weekly earnings through public sector banks (PSBs) to their dependants living in villages.

Further, with larger presence in rural and semi-urban areas, the PSBs would be having maximum number of small savings bank account holders. Generally, the PSBs were attracting small customers along with other high value depositors, who trust PSBs compared to other private sector banks.

Maintaining an account with huge balance in savings bank would be cheaper for banks than maintaining an account with small balances as transaction cost of banks would be higher in the case of small account holders. In the case of salaried employees, their salaries would be credited to a particular bank. As the regulator frees the savings bank rate, the private sector and foreign banks will offer boutique products and fascinating interest rates to attract these huge accounts from corporates as well as government organisations.

Deregulation of savings bank rate would work against financial inclusion as public sector banks saddle with all un-remunerative accounts and all high value accounts would migrate to the new generation private sector banks and the foreign banks. Always the small customer is at the receiving end.

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