Finally, after holding up for several months, interest rates on long-term deposits offered by public sector banks have crashed well below the critical 8% mark – the minimum rate on various small savings schemes run by the government. Term deposits of 3-5 years now earn 7.25-7.75%, down from nearly double-digit rates offered up to December 2008. Ten public sector banks, including the country?s largest lender State Bank of India, now offer these rates.

This means banks are finally in a position to offer lending below 10% to most industries given reduced fears of interest rate arbitrage between them and schemes like the Public Provident Fund. Bankers have so far told Reserve Bank of India (RBI) that they couldn?t pare deposit rates below those on small savings schemes, even though RBI governor D Subbarao argued in the 2009-10 monetary policy that this was possible.

The savings of Indian households was Rs 7,34,653 crore in 2007-08, of which over 55%, or Rs 4,06,630 crore, is in bank deposits, according to the latest RBI figures. Bank deposits as defined by RBI, includes cooperative and non-credit societies.

Bank of India CMD and Indian Banks? Association chairman TS Narayanasami agreed that a rate differential of 1% between bank deposits and small savings schemes would not matter much to customers.

?Even though the rates on term deposits are now lower than on small savings schemes, customers get benefits like easy availability of loans and pre-closure at short notice, which are not available in small savings schemes,? he said. He estimated that only about 5-10% of total deposits might shift from bank deposits to small savings schemes through interest rate arbitrage.

Punjab National Bank CMD KC Chakrabarty said the reduction in deposit rates would bring down costs over time in the same proportion.

A senior government official said the 400-basis point cut in the cash reserve ratio (CRR)–the amount compulsorily set aside by RBI from the amount banks can lend?since mid-September has also helped moderate overall cost of deposits. Banks can now instead deploy the funds released by RBI with industry and earn an income. They do not earn any returns on CRR parked with RBI.

Allen CA Pereira, CMD, Bank of Maharashtra, which is now offering 7.5% rates on five-year deposits, said that at this rate some investors may shift to small savings schemes, but the exact impact has to be gauged. ?Due to pressures to bring down lending rates, we have to bring down interest rates on deposits as that?s the only way to reduce costs. We can?t reduce costs on salaries and rent, neither can we hike fees or other charges on our services quickly. At the same time, we have to maintain a reasonable (net interest) margin of 3%,? he said.

In its annual monetary policy for 2009-10, while acknowledging that the 8% administered rate on small savings was acting as a floor, Subbarao had said there was scope to pare deposit rates below those offered on small savings schemes, as the two are not perfect substitutes.

Time deposits of scheduled commercial banks rose by Rs 31,495 crore during the fortnight ended April 24, while demand deposits fell by Rs 9,538 crore in the same fortnight, RBI?s latest data showed. Total outstanding bank deposits stood at Rs 39,23,000 crore as on April 24.

As high deposit rates made it costly for industry to access bank credit, these funds have been poured into the risk-free RBI reverse repo window. Since Monday, for instance, banks have invested their surplus at an average of Rs 1.5 lakh crore a day with RBI at a paltry 3.25%.

Narayanasami said long-term deposit rates have now hit bottom and wouldn?t fall further unless RBI cuts rates again. The availability of surplus liquidity and continuity in time deposits has enabled the reduction in deposit rates.

?Rates have come down as there is excess liquidity with us. But the rates are unlikely to come down further as we cannot stop accepting deposits from the public,? he added.