Saving grace

Deregulation of interest rates on savings deposits is an idea whose time has come. For eight years now, interest rates on savings bank deposits have remained capped at 3.5 per cent a year. Given that nearly a quarter of the deposits in the banking system come under this category, bank margins gained considerable stability from this ‘cost control' measure, though it was not very fair to bank customers. Given the high levels of inflation over the past few years, real rates of interest for such customers have often been in the negative. The Reserve Bank of India's discussion paper on the subject signals the direction of change. A year ago, the RBI had asked banks to calculate savings bank interest rates on a daily basis rather than on the minimum balance in a month, though this was pushed through only after overcoming resistance from banks entrenched in their ways.

Banks were allowed to offer lower rates on savings accounts because customers could withdraw their balances any time and put through a relatively high number of transactions. However, studies show that customers tend to use these accounts more for savings than for transactions. Only, it is not clear how long they keep their ‘savings portions' in these balances. And banks, recognising this behaviour, have treated a substantial part of such savings balances as ‘core deposits' for long-term lending and to account for asset-liability matches. Deregulation of the savings rate will foster competition among banks, pushing up interest rates and enabling product innovations to benefit depositors. New banks may certainly benefit as they can afford to offer their savings bank customers rates that are a tad higher rather than pay the much higher market rates prevailing for wholesale deposits. Yes, banks will find their interest expenses moving up and their margins coming under a bit of pressure in the short run, when rates are freed. But, as the discussion paper points out, fears of unhealthy competition in setting savings bank rates are perhaps exaggerated. Going by the experience of decontrol of term deposit rates, there may be a hiccup or two down the line, but nothing more serious.

Savings rate deregulation will remove one of the last vestiges of administrative control on interest rates. As the regulator admits, this will also help improve policy transmission mechanism. International experience in this regard has been encouraging and can only bolster the case for freeing these rates sooner than later. Of course, no deregulation is an unmitigated blessing. Savers, especially pensioners, who lock up a large part of their savings in such accounts, may look back wistfully at an era when they got an assured return. For rates that go up can also come down when banks have enough money on their hands. It is up to banks to bring in innovations while minimising the disruptions, so that customers get a fair deal.

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