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Will savings rate deregulation help banks?

Business Standard  |  New Delhi 

Not unless it is accompanied by other essential reforms, such as liberalisation of priority sector norms, but banks now have the freedom to manage their money better.

Chief Economist, Bank of Baroda

Deregulation of interest rates from the liabilities side without liberalising all rates from the assets side results in a distortion

The Reserve Bank of India’s (RBI’s) recent move to deregulate interest rates on savings bank (SB) deposits is seemingly justified in the interest of fairness and equity, as the rate was administered at 3.5 per cent for more than eight years and then raised to four per cent in May, 2011 despite sticky inflationary pressures for more than 40 months. It was considered unfair that depositors, who provide almost one-fourth of the total stock of bank deposits, were not given any protection against rising inflation. Also, the move was deemed essential to promote product innovation and price discovery in the long run, since deregulated SB rates might encourage banks to judiciously manage and promote efficient resource allocation.

However, the move may not fetch the desired results, since half-hearted deregulation can be worse than none at all. The deregulation of SB rates should have been accompanied with other essential reforms – like the reduction in the overall resource preemption levels, liberalisation of priority sector lending norms, deregulation of other administered rates like interest rates on crop loans or export credit and so on – for the creation of a fair, market-driven banking system. Moreover, interest rates on other important savings products with which bank deposits directly compete are still administered in India. For instance, interest rates on the small savings, pension and provident fund schemes of the central and state governments are not market-determined.

In the current phase of rising interest rates and increasing volumes of government market borrowings, the SB deregulation may discourage banks to undertake aggressive efforts towards financial inclusion (due to higher cost of funds) and also hamper their efforts to extend low-yielding social advances. If the administered SB rates acted as the “subsidy” for public sector banks, it may not be forgotten that these were the banks that lent unfailingly to low-yielding social sectors even during the global crisis years. In other Bric countries like China and Brazil, SB rates are “regulated” precisely for this reason. Deregulation of interest rates from the liabilities side without liberalising all rates from the assets side results in a distortion.

Let us now look at the experience of those countries in which SB rates are deregulated for quite some time. In countries like South Korea, Taiwan, Singapore and Malaysia, SB rates have settled at extremely low levels over the period of time. For instance, at present, the SB rate rules around 0.10 per cent in South Korea, 0.31 per cent in Taiwan, between 0.25 and 0.35 per cent in Singapore and between 0.40 and 0.70 per cent in Malaysia. Even in India, once interest rates start easing, the competitive pressures will force this rate to settle at abysmally low levels. This will then be considered extremely unfair to small savers who lack organised representation. While large and learned depositors will enjoy many choices, small savers from remote rural areas will get exploited because of their ignorance. This means will have to intervene and come out with a minimum floor rate to protect small savers.

As was done in Hong Kong, I think Indian regulators could have implemented the deregulation of SB rates in a calibrated fashion with many checks and balances. As some experts suggested, the regulator could have timed the deregulation when the interest rate trajectory was stable so that the decontrolled rate would not result in abrupt changes. Given India’s present social landscape, the regulator could have come out with a minimum floor and a cap on this historically “clean” product (with uniform rate to all savers irrespective of their social, economic, locational or educational status) to avoid chaos.

As SB rate deregulation is introduced in India in the present tight conditions, there is a possibility of an unhealthy rate war among banks, giving way to heightened volatility in their resource profile. This certainly does not augur well for their ability to fund long-term projects. Till the time India lacks reliable alternatives in the form of a liquid and well-developed corporate bond market or easy access for its banking sector to long-term instruments of funds, deregulating the SB rate may not yield the desired results.

One has to wait and watch.

Chief Economist, CARE Ratings

helps banks manage their costs more efficiently because they can fine-tune them depending on their requirements

Deregulation of interest rates on savings deposits is probably the last mile in interest rate reforms in India. Though the timing may be debated, banks will surely see something good in this move. For the system as a whole these deposits constitute a little less than a quarter of overall funds — they have increased from around 21 per cent in FY00 to 25 per cent in FY06 and moved down to 23 per cent in FY10. There are four reasons for banks to cheer.

First, the freedom to price around a quarter of available funds gives them better control over an important section of their funds. Second, helps banks manage their costs more efficiently because they can fine-tune them depending on their own requirements and market conditions. The fact that these deposits are almost constant can give most banks flexibility in pricing, although ironically the mirror image would offer scope for competition to dip into them. Third, banks can increase or decrease this reservoir of funds to the extent that is possible based on their own requirements. This will foster competition between banks and enable them to compete with liquid mutual funds, which are the direct alternative. Also by changing terms of transactions like minimum balance, charges for services and so on, they can encourage or discourage such deposits. Finally, as a consequence of these three factors, asset-liability management becomes easier since banks can factor movement in these deposits to match maturity of assets.

Though it is true that these deposits have been an almost constant factor for the banking system, these dynamics may change gradually once customers see differential interest rates. One cannot conjecture whether this proportion of 23 per cent will move up or down when rates change. This was also observed when banks started very short-of 15 days and above — a move to get customers to roll over these deposits at a rate that was higher than the savings account rate. Customers did move funds to banks offering higher rates on these deposits. By offering higher rates on savings accounts, there could be migration to these deposits not just within the bank, but also across banks. This will cut administrative costs. Therefore, at the micro level, banks will have scope to play with their balance sheet more effectively.

Individuals usually hold cash at home for liquidity, savings deposits for and convenience, and for income. While funds may be swapped between banks or across deposits, the overall amount of deposits may not change if rates are increased, given the profile of customers who are already exposed to various alternatives. Therefore, at the macro level the impact may be minimal since it should be recognised that liquid debt funds tend to give higher post-tax yields. Similarly, if the rates come down, customers may not actually withdraw substantially from this account.

We have already seen disparate reactions from banks. The large ones have been silent, while some smaller ones have increased these rates. This will really be the challenge for banks at the micro level where the share of savings accounts is lower, as in the case of foreign banks (about 15 per cent) and old private banks (around 19 per cent). Those that are already at 23-24 per cent may not really have scope to do so, based on past trends in terms of garnering deposits. The onus will be on banks to actually manage this portion of funds.

So, is it good for the banking system? Certainly yes, since it gives banks the freedom to manage their funds more adroitly. The consequences of the impact on the amount of deposits may not change but as long as it is market-determined, the system will be efficient. The real challenge is for the Reserve Bank of India when interest rates come down substantially — as they did in 2002-2005 when gave returns of around five per cent. Logically, the savings rate should have also come down proportionately to close to nil in case a spread of, say, 400-500 basis points is to be maintained as is the case today.

This may be tough to accept.

These views are personal

First Published: Wed, November 09 2011. 00:47 IST