Pulling out another item from its cornucopia of surprises, RBI announced a complete deregulation of the interest rate on savings deposit accounts with banks in late October. This followed an instruction to calculate interest on daily balances on savings accounts from April 2010 (banks had been using, to compute interest on savings, quarterly minimum balances, prior to this) and then increased the rate from the erstwhile 3.5% to 4%, earlier this year. The overall effect of these moves had been to increase the cost of funds for banks, which was consistent with the tightening monetary policy stance of RBI from around this period. This has effectively freed the last restriction on interest rates, on the liabilities side of the domestic banking sector (there remain restrictions on the lending side, and on NRI deposits).
What might have led RBI to take this (unexpected) step? The timing, not the decision itself, was the surprise, mind, since the deregulation had been accepted, in principle, as a critical part of financial sector reforms, particularly in enabling the emergence of a proper sovereign yield curve, which would reflect market cost of funds across the yield curve. An immediate corollary to this is to induce better transmission of monetary policy signals, by freeing up rate constraints on a pool of funds, which is about a quarter of the R54 lakh crore of liabilities on the banking sector. But this is undoubtedly a huge step for financial sector reforms, in line with policy efforts to induce greater competition.
But the timing? Banks had been unanimous in their view that savings rate deregulation would have been counterproductive and induced large volatility in interest rates, in an environment of tight liquidity and rising policy rates. It might have been a coincidence that this decision came bundled with a policy review with an explicit guidance on the balance of probability favouring a policy rate pause, and in an environment where overnight and short-term interest rates have remained stable, despite a steep rise
in global risk aversion and the consequent reduction in dollar lines of funding for Indian banks and corporates. Domestic liquidity has also remained manageable, and current indications are that they are likely to remain so for the rest of the year. In short, this might have been a double-barrelled message on (a) a marginal reinforcement of the 25 basis points increase in the repo rate and (b) of a change in the tightening stance of monetary policy.
So what might be the likely effects? RBI has gone to great lengths to emphasise (at the post policy conference with media and analysts and other forums) that it wants to encourage ?product innovation? for savings deposit accounts, with the presumed objective of inducing a more rational deployment of savings for individuals across savings and fixed deposits.
For the banking system as a whole, this behaviour of savers and depositors remains relatively ?un-understood?, although individual banks have a much better understanding of the behaviour of their own depositors. What little is known of system deposits is as follows. To reiterate, savings deposits comprised about 28% of deposits in 2001-11, and have ranged between 20% and 53% over the past 10 years. Urban savings accounted for 60% of total savings deposits in 2010, but only 40% of the number of accounts. Per account balances in urban areas were 2.5 times those in rural and semi-urban areas. Per account balances in foreign banks were 5 times those of public sector banks and 3 times of private banks.
Of course, one would expect that the entities with the biggest incentive to switch accounts based on rate differentials would be the large depositors. These depositors?trusts, educational and religious institutions, high net worth individuals?comprise about 7-8% of deposit amounts (although the number would be far smaller by way of deposit accounts).
The dynamics of deregulation have already started operating; a few banks with smaller savings deposit bases have already announced increases in their savings deposit accounts. How a larger part of the system reacts will be determined by multiple factors, including demand for credit funds, the maturity structure of term deposits, and asset liability mismatches. Banks which will be able to deliver value proposition for their savings deposits are likely to benefit the most in this fluid environment.
The author is senior vice-president, Business & Economic Research, Axis Bank. These are his personal views