Time to revisit deposit rates

In October 2011, the Reserve Bank of India deregulated the interest rate on savings bank deposits in order to improve monetary policy transmission. However, the post-deregulation experience has been stickiness of this interest rate at 4 per cent offered by the public sector banks (PSBs) — a clear case of cartelisation by PSBs.

Although the private sector banks (PvSBs) offered relatively higher rates, their SB deposit rates also remained relatively inflexible compared to their fixed deposit rates. The very purpose of deregulation of interest rate on saving bank deposits seems to have been defeated.

Despite higher interest rates on SB deposits offered by PvSBs, there was no major shift of savings deposit from PSBs to PvSBs during the post-deregulation period mainly due to the latter generally asking their depositors to maintain a significantly higher minimum balance. As the minimum balance was different for different PvSBs, their SB account interest rates were also non-identical.

The SB deposit falls somewhere between the current account deposit and fixed deposit, and therefore such depositors should get an interest rate at least equivalent to average inflation rate, let alone positive real interest rate advocated for fixed deposits. In the case of PSBs, the SB interest rate at 4 per cent is below the average inflation rate.

In the case of both PSBs and PvSBs, depositors are denied the fixed deposit rate for their minimum balance, which anyway remains with banks on a continuous basis. In either case, depositors were at the receiving end and lost the market-determined interest rates.

RBI regulations permit withdrawal restrictions on savings bank accounts in order to distinguish between SB account and current account on which payment of interest is currently prohibited. This regulation has become redundant ever since the RBI permitted paying interest on SB deposits on the basis of daily balance.

Of late, both PSBs and PvSBs have started imposing withdrawal restrictions, keeping in view that such restrictions are permitted by RBI regulation. This is, in fact, the legacy of the regulated regime. Some PSBs have also increased the minimum balance recently, without raising the SB interest rate.

Currently, many banks have arrangement with some of their customers such as salary account holders or even current account holders, to have a sweep account facility to compensate the valued customers at short-term fixed deposit rates by sweeping their balance in SB/current accounts to fixed deposits. If this is possible, why not pay a higher rate of interest on the minimum balance maintained in the SB accounts? The argument that ‘servicing an SB account is high’ is no more valid in the age of robust technology.

The time has come to revisit the pricing of SB deposits. The minimum balance in the SB account stipulated by each bank board should be treated as fixed deposit, which should attract fixed deposit rates. The interest rate on the variable portion of the SB deposit may be linked to a market-based benchmark. The average inflation rate of the previous quarter may be a good proxy for a market-based benchmark. For this purpose, inflation should be measured by variation in the headline CPI.

Commercial banks have to reset the interest rate of the variable portion of SB deposits at quarterly intervals. The composite real return on an SB account would turn out to be marginally positive as the nominal interest rate on minimum balance is priced higher, equivalent to one year fixed deposit rate.

In the inflation targeting regime, the RBI has a clear mandate to achieve CPI inflation at 4 per cent with a band of plus/minus 2 per cent. If the RBI is successful in achieving 4 per cent CPI inflation for the previous quarter — the central rate under inflation targeting — then SB interest rate for the flexible portion shall be 4 per cent. In case the CPI inflation comes down below 4 per cent, an SB deposit would earn less than the current rate for its variable portion.

A two-way movement of interest rate on SB deposits is clearly visible, which will make this rate flexible and help improve monetary transmission. Commercial banks can still make profits on such deposits under the proposed pricing of SB deposits. Even a lazy bank can earn profits by putting this money back into the RBI under the fixed rate reverse repo operation as the reverse repo rate is expected to remain above the average inflation rate. If banks invest this money in any of the money market instruments — call money, CD, CP, or 91-day Treasury Bills — they would get a spread over the reverse repo rate and may be much higher than the average inflation rate in the previous quarter.

Since the RBI has deregulated the SB interest rate, re-regulation of this rate may be a retrograde step. However, the RBI can suggest to banks to adopt a market-based benchmark to arrive at the interest rate on the variable portion of SB deposits.

So far as minimum balance in the SB account is concerned, there is a clear case of pricing the same at par with the one-year fixed deposit rate. Moreover, the RBI can remove withdrawal restrictions on SB accounts, which has become redundant in the current milieu. Commercial banks may do so at their own peril and lose business to other banks who do not impose any such restrictions.

Indian households make a large number of small payments in their day-to-day transactions. They can do so in the digital mode as well. The number of cash withdrawals may come down going forward. But restrictions on the number of cash withdrawals at this stage may lead to hoarding of cash by Indian households. This is likely to hinder the progress of digitisation.

Banks should popularize digitisation and thereby gain due to a dramatic fall in the transaction cost. This is the best way to wean customers away from cash to non-cash, rather than by forcing them to hold more cash through withdrawal restrictions.

The writer is former Principal Adviser and Head of the Monetary Policy Department, RBI

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