During a crisis like the Covid-19 pandemic, savers are a neglected lot. Not only do they save less during the crisis due to fall in their income, but they also lose their existing savings rapidly. In an otherwise illiquid market, most physical savings have lost value, except gold. Investment in gold is often considered as a safe haven for households. However, this option is also choked, as international prices of gold have gone up amidst Covid-19 related uncertainties. Moreover, the rupee value of gold in India has shot up greatly following depreciation of rupee.

Let’s take a deeper look at financial savings and their major components. First, investment in capital market has gone for fire sale. Many investors in the capital market have lost their life savings following its collapse, wiping out more than 40 per cent of the market capitalisation in India from its peak in January 2020. To salvage a part of the principal, many investors have redeemed their investment in mutual funds, even if the net asset values have declined significantly. Many investors in corporate bonds may not get back their principal due to potential default, which is likely to materialise in a few months due to severe cash flow problems arising out of nationwide lockdown for 40 days.

Depositors’ woes

A bulk of the household savings in India is held in the form of bank deposits. Interest rate risks are very high for all term deposits due for renewal. As the RBI has flooded the market with excess liquidity — close to ₹7 trillion in April 2020 — banks do not care for depositors. Many commercial banks have already reduced their deposit rates (both term and savings deposits) and/or are on the verge of further reduction going forward. Real deposit rates have become negative for last several months. As the RBI has made long-term provisions for liquidity through long-term repo operations (LTROs) and two rounds of targeted LTROs (TLTROs) so far, depositors have no hope for increase in deposit rates in the medium term.

Following the fear of ‘once beaten twice shy’, households are reluctant to move to the capital market, even if the valuations of shares are attractive at this point of time. Hence, banks/other deposit-taking institutions take depositors for a ride by ruthlessly cutting rates on all new as well as old deposits due for renewal. Many senior citizens in India, who predominantly depend on interest income, will face hardship as it declines going forward.

In 2020-21, deposit growth is unlikely to be impressive mainly due to fall in income, besides cut in deposit rates. If a sizeable section of depositors, including high net-worth individuals, shift their savings from bank deposits to the capital market or real estate out of frustration or indulge in aggressive mis-selling through unscrupulous investment advisers, financial savings as proportion to the GDP would fall further on top of the declining trend that is being observed since the global financial crisis. Moreover, this is likely to create mismatch between assets and liabilities in the balance sheet of commercial banks.

Regulatory measures

In an inflation-targeting regime, flooding the market with excess liquidity cannot be sustained for a long period. Banks cannot enjoy the luxury of long-term liquidity under LTROs/TLTROs on a permanent basis. Sooner or later, banks have to depend on deposit resources to comply with several regulatory requirements in the medium term. Hence, the asset-liability mismatch would neither serve the interest of depositors nor the intermediaries.

In order to protect the interests of both borrowers and lenders, the RBI has taken a slew of measures such as a moratorium in the payment of EMIs, LTROs/TLTROs, deep cut in the policy repo rate/cash reserve ratio, exemption of SLR for accommodation of banks under marginal standing facility and so on.

While these measures were considered necessary for sustaining the supply of credit to the productive sectors at reasonable/reduced cost, the unintended victims have been the poor depositors.

Flexible deposit rate system

The current turmoil in the financial markets, arising out of the Covid-19 pandemic, is likely to continue for a longer period than what was initially believed. As depositors are a major stakeholder in the economy, their protection is also necessary in a difficult time like Covid-19 crisis. The RBI should devise ways to safeguard depositors’ interest. Specific suggestions in this regards are as follows:

Let the commercial banks freeze all deposit rates for new term deposits at the January 2020 level for one year.

Any term deposit due for renewal between January 2020-January 2021 may be renewed at the old rate or the rate prevailing on the cut-off date, whichever is higher.

Alternatively, all new and old deposits (due for renewal) during the above period may be given a positive real return, at least 2 per cent above the average CPI inflation rate of the previous corresponding period equal to the tenor of deposits, or the old fixed rate, whichever is higher.

Pursuant to recommendations of several high powered committees, it is an opportune time to adopt a flexible deposit rate system in India. Banks’ net interest margin has improved considerably following the RBI’s recent policy measures, particularly the provision for medium-term liquidity through the LTROs/TLTROs. Hence, the RBI should nudge the commercial banks to switch over to a flexible deposit rate system linked to an external benchmark — preferably the CPI inflation rate — and resolve the ongoing problem of monetary policy transmission.

Borrowers typically have a forceful voice in the policy-making process and extract relief during a crisis. But unlike them, depositors have hardly any voice, although they are important stakeholders in the economy. Hopefully, in a Covid-19 ravaged financial system, depositors would be protected either through status quo on deposit interest rates or through a flexible deposit rate system, that provides inflation-linked real returns and improves the monetary policy transmission in India.

The writer is a Visiting Fellow at IGIDR and former head of the RBI’s Monetary Policy Department

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