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Banking: The 'negative return' savings account... - Views on News from Equitymaster

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Banking: The 'negative return' savings account...

May 25, 2007

31% of India's population has a bank account (source: RBI). The average size of a deposit account in the rural areas is about one-third the size in urban areas and ranges from about Rs 7,000 (in Andhra Pradesh) to about Rs 17,000 (in Punjab). Savings accounts (27% of total system deposits) form a major chunk of this due to its maneuverability across deposit sizes. Term deposits (60% of total system deposits), which typically enjoy the benefit of rise in interest rates, however, have been camouflaging the relevance of the savings deposits, and at the same time growing at an accelerated pace in the past two years.

Much water has flown under the bridge since the Reserve Bank of India (RBI) adopted a 'status-quo' policy with regard to the plain vanilla savings bank accounts a year ago. Interest rates have moved northward since then, along with inflation rates. The central bank's assumptions are no longer valid, and yet, in its latest pronouncements with regards to the credit and monetary policy stance for FY08, it has maintained a stony silence on this issue. To quote the latest Trend and Progress of Banking in India (2006), "Based on a review of prevailing monetary and interest rate conditions, the annual policy statement for FY07 considered it appropriate to maintain the status quo while recognising that the deregulation of savings bank deposit rate was essential for product innovation and price discovery in the long run".

While the urban and metropolitan citizens may find the argument irrelevant, it must be noted that the savings account is the only type of bank deposit millions of households in semi urban and rural areas are familiar with. This explains why, despite a steep hike in deposit rates of late, there has been no let-up in the pace of accumulation of resources under this category. Having said that, since the savings accounts still make up about a quarter of all bank deposits, it is only fair that they too benefit from a regime of high interest rates.

The current rate of interest of 3.5% on savings account was fixed on March 1, 2003 (lowering it from 4%). In the context of rising prices, with the inflation rate (WPI) hovering above 6%, the real interest rate earned on the savings account is negative. In 2003, when the RBI had tinkered with the savings bank interest rates, a term deposit of up to one year fetched a return of 4.25% to 5.25%, while those between one and two years yielded 5% to 6%. Now, while the savings bank interest is unchanged, the interest rate on deposits of up to one year has soared to as high as 5.5% to 7.5% and those for one to two years are fetching between 8.5% to 10.5%. In effect, the current interest rate scenario warrants an upward revision in the savings bank rate, to buy the argument that the RBI had advanced while unveiling the credit policy last year.

Further, for a typical savings bank account, interest is paid only on the minimum balance lying to the credit of the savings bank account holder between the 10th and the last day of the month. Fairness demands that the interest be computed on the average balance for the month, if not on the daily balance of the depositor. Here too, the savings bank account holder is at the receiving end.

Interest rates on term deposits were deregulated in October 1997 and the only exception was the savings account. One of the main reasons for the delay in going ahead with the deregulation of the interest rate on savings deposits has been the unwillingness on the part of banks to forgo the easy access to cheap funds through the savings deposits. Given that the RBI is now empowered to disband the old framework in regard to cash reserve ratio and statutory liquidity ratio, its policy on the savings account seems archaic. As the central bank itself had put it, the deregulation would facilitate better asset-liability management for banks and competitive pricing to benefit the holders of savings bank accounts.

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