A Reserve Bank of India discussion paper has come out in favour of deregulating the interest rate on savings deposit, the only deposit interest rate that is still administered by the RBI; it has remained unchanged at 3.5 per cent since March 2003. Every other kind of deposit stands deregulated, the process, which started in the early 1990s, having been largely completed by October 1997. Now, banks have the freedom to set the interest rates on those deposits and loans. Deregulation has spurred competition in the financial sector, imparted greater efficiency in resources allocation, and strengthened the transmission mechanism of monetary policy. If the SB rate has not been deregulated so far, it is because of a belief that the regulator would take better care of the interests of these depositors, who are mostly from low income households in rural and semi-urban areas. This argument has lost its edge today because a wide range of investment and deposit options have been made available for all types of customers. In fact, if banks are allowed to fix their own rates on SB deposits, they might choose to reward all their depositors with higher rates. Innovation will also get a boost in a decontrolled environment. All these are extremely relevant in the context of the current policy thrust towards financial inclusion.
The other major argument against freeing the SB interest rate comes from the banks. Savings bank deposits constitute more than a fifth of the total deposits and more than 84 per cent of them are from households. Although these accounts are used for transactions, empirical evidence suggests that a significant proportion remains as savings. Over time, many public sector banks have come to depend on the stable core of savings deposits to bridge the asset-liability mismatch in their balance sheets. In a decontrolled scenario, this cannot be taken for granted as it would be unrealistic to expect SB depositors to stay on if their bank does not match the interest rate or the quality of service offered by others. Yet the view that there will be unhealthy competition among banks leading to a reckless bidding for savings deposits is not valid. After all, term deposit interest rates have been freed for a while now and, barring isolated instances, the deposit rates tend to converge within a narrow range. Considering the generally high rates of inflation, the SB interest rate has yielded negative real returns over a fairly long period. For the common man, the SB deposit account is the first, and often the only, point of contact with the banking system. It is time that a major disincentive in the form of low, administered deposit rate is removed.
