Savings-bank account-holders have been earning negative real interest rates for quite some time, as inflation has exceeded the administratively determined 3.5 per cent return on such deposits.
The central bank now wants to take the final plunge of deregulating the last bastion of regulated interest rates. Some of the concerns of the central bank have been put forth in a discussion paper on deregulation of savings bank (SB) rates in late April 2011.
CASE FOR DEREGULATION
The discussion paper has posed a few questions for feedback. First, is the issue of an administered nature of interest rate on savings bank deposits itself. In the present system, there is only one administratively determined interest rate applicable to SB depositors of all categories, and irrespective of geographical location.
However, banks practice differentiation in the SB deposit space extending additional services to customers who maintain balance in SB accounts beyond a threshold. The nature of additional services like free locker facility, waiver of loan processing charges, etc, differs from one bank to another and in that sense there is already competition in the SB deposit space.
Even so, large value SB depositors subsidise some of the services offered to the small value SB depositors. Cross-subsidisation is not advisable from an economic efficiency point of view.
Post-deregulation, the competition in the SB space will be more explicit, but the market mechanism will ensure that the price discovery will take place in a manner that will serve the interest of both banks and depositors.
PROTECTING SMALL SAVERS
The second issue pertains to how to protect the interest of small savers in general and that of senior citizens, pensioners and no-frill account holders post deregulation.
One way of protecting the interest of small savers would be to link the return on such deposits to a policy rate. The ideal policy rate for this purpose would be the reverse repo rate.
The reverse repo rate is the rate at which RBI pays interest to the banks for the overnight deposits parked with it.
The reverse repo acts as the floor of the interest rate corridor within which RBI would like the short term money market rates to fluctuate. It would be logical as well as just that banks pay a rate to small savers linked to what they get when they have surplus funds in the short term horizon.
The RBI can think of putting a minimum floor of, say, 3 per cent less than the reverse repo rate, for the SB rate after taking into account the negative carry costs associated with SB deposits such as maintenance of CRR and SLR by the banks. The minimum floor rate would be adjusted as the policy stance changes, reflecting liquidity situation. The spread between the reverse repo rate and the floor for SB rate should also be flexible.
IMPACT OF NEW REGIME
The empirical study undertaken in the discussion paper suggests that interest rate differential between savings and term deposits plays a role in deciding the share of savings bank deposits in the total deposits in all regions, except the metropolitan areas. In other words, savings bank deposits are rate-sensitive in rural, semi-urban and urban areas. Based on the empirical results, the discussion paper maintains that post deregulation, the attractiveness of savings deposits in the rural, semi urban and urban areas will increase.
This line of reasoning assumes that rates on SB deposits will increase post deregulation. This need not be the case. Further, there are issues related to the choice of variables which needs to be considered while reading the empirical results.
The reference of term deposit rate used for the empirical exercise is the term deposits of maturity of ‘1-3 years' and ‘6 months to 1 year'. If one used the term deposit rate of a shorter duration than what has been used, the results could vary. Based on the empirical results, the discussion paper maintains that rate is a deciding factor in small savings in the rural areas but not in metropolitan areas.
This sounds counter-intuitive as customers have more choice to strike a better deal in metros than in rural areas.
STATE OF PREPAREDENESS
Another question the discussion paper poses is whether it is the right time to go for deregulation of SB rate. Indian banking system has transited quite nicely from a regulated interest rate environment to a deregulated one.
The savings bank rate remains the only major banking product whose price is administratively determined.
Over the last two decades of reforms, Indian banks have developed maturity and competence in pricing the various loan and deposits products. There is no reason to believe that banks cannot appropriately price saving bank deposits.
Moreover, the opinion of the banking fraternity was not sought before deregulating the interest rate on other deposit products. It was the central bank's decision, and rightly so, to go in for a deregulated interest rate environment that helps in better allocation of resources and in improving the overall efficiency of the system.