The Hindu Business Line : Banks continue to have the cake and eat it too

FOR long, the public placing funds in bank deposits had suspected an unfair deal from bankers. Confirmation now comes from the Report of the Advisory Committee to advise on the administered interest rates and rationalisation of saving instruments (Rakesh Mohan report).

The report was kept on Government files till the Union Budget was presented and now is available on the RBI Web site. The committee has cared to look beyond benchmarking small saving rates to market trends. A sharp rise in capital inflows has weighed down interest rates since 2001, shrinking the real interest incomes of retirees and pensioners.

The report says: " For instance, the average money market rates declined by nearly 350 basis points, long-term yield in government securities and deposit rates offered by banks declined by over 500 and 425 basis points, respectively, over the last three years culminating in the real bank deposit rate turning close to zero and at times negative, notwithstanding a sharp fall in headline inflation rates."

This trend got the Government to come up with the Dada-Dadi bonds, though that does not help those at their working desks.

What the report does not state is that banks have been working on high spreads even at the current PLR ranging between 10.25 and 11 per cent. In sharp contrast, those placing funds in small savings instruments gained hugely with the growth in small savings being "significantly higher" than that of bank deposits in recent years.

The report has estimated the effective returns on various small savings schemes using the internal rate of return on accruable net cash flow streams for various schemes, adjusted for different tax brackets of 0, 10, 20 and 30 per cent.

The effective yields on certain schemes at present are placed at 14.6-16 per cent while the nominal yields on these instruments were higher by 650-800 basis points at the highest income tax bracket.

While the effective yield differential for post office time deposit (5 years) for alternate income tax brackets is 7.7-10.03 per cent, the same for the NSC VIII issue for almost similar maturity stands at 8.16-14.60 per cent. "Thus the system, is rendered regressive in terms of the wide divergence in returns as between taxpayers and non-tax payers as well as among taxpayers in different income brackets," the Report admits.

If this trend continues, bank deposit growth may not be the best indicator for monetary policy. Looking into the linkages between interest rates on small savings and bank deposits, the report finds: " ... ... , the sensitivity of small saving mobilisation to the interest rate offered on competing saving instruments (bank deposits) is also significant.

For example, the co-relation coefficient between the year-on-year growth of small savings and deposit rate spread (5-year post office deposit rate minus 3-5 year bank deposit rate) is over 0.6.

Technical studies conducted by the Committee show that administered interest rates such as postal term deposit rates are significantly associated with commercial bank deposit rates. ... . This also establishes the fact that stickiness in the administered interest rates on small saving interest rates results in higher mobilisation under small savings at a time when the market rates are falling and vice versa."

At another place, the report finds "that the deposit rates of commercial banks are significantly influenced by administered interest rates with an average sensitivity of about 35 basis points in response to a single percentage change in the latter."

Administered saving rates have to be brought down, no doubt, a point made by the earlier Reddy committee; but with bank deposits yielding zilch returns, will the system be fair to the frugal populace?

It would have made sense if the commercial banks had brought down lending rates and that is not happening.

A personal loan for an ordinary depositor bears an interest tag of 13 per cent, a farm loan costs vary between 10 per cent and 12 per cent (the two are never rated) while a triple rated corporate still gets funds at 7-8 per cent.

Why are the RBI and the Finance Ministry reluctant to at least appoint a high-level team to study the way lending rates are fixed by banks? It could make more sense.

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