Cut in bank deposit rates, a bias against depositors

After the first meeting of the chiefs of banks with the Finance Minister P. Chidambaram, some commercial banks decreased their lending rates.

At that point, it was quite expected that a downward revision in deposit rates would follow.

And that has come true. The industry leader SBI has reduced its term deposit rates by 50 to 100 basis points across-the-board with effect from September 7. Others will follow suit sooner or later. The apparent reason is to protect net interest margins of banks.

Juxtapose the reduction in deposit rates with the reigning rate of inflation — be it WPI or CPI — which the RBI repeatedly and rightly characterises as “stubbornly high” and hovering around 9-10 per cent. This gives an equally stubbornly high negative real rate of returns to the bank depositors, the largest chunk of which belongs to the lower and middle class that constitutes the highly vulnerable sections of the society.

What is more important from the depositors’ perspective is not the real rate of interest, but the real rate of interest defined as the differential between rate of interest and the expected rate of inflation denoted by Pe, which is expected to be no different, if not higher, from what the actual rate of inflation today is. The upward bias in inflation rate will continue as per current cues. All this will have an adverse impact on the propensity to save in banks by householders.

Decline in savings

In fact, the process has already taken roots with net household savings reducing from 25.4 per cent of GDP at current market prices (Provisional) in 2009-10 to 22.8 per cent (Quick Estimates) according to the RBI Annual Report 2011-12. However, more striking is the decline in householders’ financial assets from 12.9 per cent to 10.0 per cent — a 290 bps fall over the same period. With financial savings declining, who will provide the resources for investment activities?

Consequently, the household sector has started putting its savings in physical assets which have risen from 12.4 per cent of GDP to 12.8 per cent of GDP over the same period. Savings in physical assets, predominantly in precious metals and stones, real estate and the like, are considered as not easily or readily available for productive ventures.

As a proportion of change in gross financial savings, deposits with commercial banks in fact increased from 41.3 per cent in 2009-10 to 48.5 per cent in 2010-11. This is good news, but the credit may not be wholeheartedly attributed to commercial banks.

The underperformance of the capital market had a lot to contribute to this phenomenon. As a proportion of change in gross financial savings, assets of the households in the form of shares and debentures actually declined by 0.7 per cent in 2010-11 over the previous year.

Overall macro scene

What do these mean for the overall macro scene for domestic savings and capital formation?

Net capital inflow has also taken a downturn. Under such circumstances, is it advisable to decrease the bank deposit rates? The NIM of commercial banks may get adversely affected and with it their profits, but it is not justified that banks should build their edifice of NIM and profits at the cost of middle class depositors?

NIM and profits of banks are also a function of structural rigidities banks are harbouring within themselves. May be a lower NIM would be the price that banks have to pay for these rigidities. Banks should not make depositors pay for that.

In the present scenario, when the depositors are sandwiched between rising prices and limited options for higher earnings from savings, banks themselves would be thwarting their low-cost and stable resource base.

This will escalate the savings in physical assets and promote current consumption by households which does not augur well for the country.

It may be mentioned that banks are facing a slow growth rate in their aggregate deposits which as on August 10 (y-o-y) grew by 14.3 per cent, much less than 18.5 per cent recorded in the similar period last year ( Source: RBI WSS, August 31, 2012 ).

Will the RBI look into this and come to the defence of the middle class bank depositors? (The author is a former commercial bank economist. The views expressed are personal)

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