Savings bank rate de-regulation: A case of hyperbole?

It would appear so if we examine the issue from the reported perspectives of the key protagonists in the debate – the regulator Reserve Bank of India and the regulated commercial banks. We have consciously not included savers/depositors as a key protagonist in our argument – because we feel that they will likely benefit if the other two protagonists were to address their core objectives and not make too much out of whether the SB rate is regulated or not.

In other words, savers will benefit if the RBI confronts “ineffective” monetary policy transmission (MPT) independent of the SB rate. In effect, this article takes the stance that SB rate de-regulation may be desirable but not a necessary condition for effective MPT.

Savers will also benefit if the rate is de-regulated and banks are compelled to bring in better maturity or duration matching in their asset/liability mix. Indeed, a contrarian stance we take in this piece is that SB rate de-regulation can potentially reduce asset/liability mismatches instead of worsening them as is widely held. So, banks may not need to worry too much on that score.

Core objectives

What are the core operational objectives for the key protagonists? For the RBI, it is effective transmission of its policy rate moves. And for the commercial banks, it is being able to run maturity mismatches strictly to the extent permitted by their risk management policy. That is, mismatches should be out of choice and not perforce.

One wonders if SB rate de-regulation is so important or inevitable for effective policy transmission. What matters when the central bank wants to influence spending and investment behavior – in the short term – in the economy is how it alters the incentives attaching to such behavior. Higher interest rates – particularly for term maturities - incentivise savings and postpone investments whereas lower interest rates can propel consumption, borrowing and spending as the opportunity cost of money declines. Should SB be a key determinant in this process?

Not necessarily.

For instance, take the slowdown in credit growth and the waning of investment confidence which has been reported recently. Now, this has taken more than a year of baby-step increases in rates and no discrete action on cash reserves (CRR) to attain this outcome. (One has to note here that the inflation outcomes may not improve contemporaneously with any slack in credit growth or mixed investment confidence).

Through the entire one-year period, the RBI has been supplying liquidity to the banking system to bridge its funding gaps at again, progressively baby-step higher interest rates, which were duly being passed on to the borrowing/spending sides.

Now, one wonders if the current outcome could not have been obtained much earlier if the RBI had taken more forceful action on constraining liquidity/or providing liquidity only at steeper rates than it did actually? That would have compelled banks to search for liquidity through a relatively more enduring source – term deposits through the medium of higher term interest rates. What is the policy transmission we are achieving when we hike our lending rates in baby steps but continue to lend liquidity to the banking system to fund its rapid asset growth?

To be sure, one can say that the RBI could not have adopted any drastic demand containment and inflation cooling measures given its multifarious responsibilities on the growth and development front.

Well, that is an issue for the Government and the RBI to settle. But, from an immediate technical perspective, one feels the SB rate is not that important here.

Asset / Liability mismatches

A key concern voiced by commercial banks is that SB rate de-regulation can potentially worsen maturity mismatches on the balance sheet. The apprehension is that de-regulation can spark off increased and unhealthy competition for SB deposits – the competition primarily driven by interest rates. Therefore, both in maturity and interest rates (spreads) terms, there could be additional problems.

It is difficult to understand why it should be necessarily so. Assuming that asset/liability maturity mismatches should be strictly within the norms laid out by your risk policy (and this policy, of course, can be dynamic), any stiffening in market rates engineered by overall monetary policy should be an incentive to elongate the maturity profile of the liabilities on the balance sheet.

Term deposits – instead of SB - should be aggressively promoted in such an environment through the medium of higher interest rates. That can effectively bring in better maturity (or to go one step further, better duration) matching on the balance sheet as term liability growth will increase at the same time as asset growth slows. Even otherwise, in normal times too, SB de-regulation could (should) provide an incentive for banks to stress the transactions nature of the “savings bank” deposit and why its rate can be somewhat insensitive to market rates.

Larger message

The SB rate debate does provide a larger message. It may be easier to arrive at expeditious decisions on issues such as regulation/de-regulation in financial markets when we look at the issues from the perspective of the core objectives to be attained. Of course, for emerging market regulators such as the RBI, given their multifarious responsibilities, that is easier said than done.

Central banks such as the RBI cannot afford to tackle such issues from a purely technical angle.

The author is Vice President (Economic Research), Shriram Group Companies, Chennai. These are his personal views.

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