Interest is paid in savings bank accounts on the lowest balance during the month. On average, about 85 per cent of savings bank deposits are interest bearing. Savings bank deposits of scheduled commercial banks accounted for about 22.5 per cent of aggregate depositors or Rs 2,50,000 crore at the end of March 2002. On the present interest rate of 4 per cent, the cost to the system is Rs 8,500 crore or Rs 2,125 crore for each percentage point.
It is clear that the banking system as a whole cannot afford any sizeable escalation of rates in any deposit rate war and it is understandable that the Reserve Bank of India has been very cautious in removing interest rate controls on savings deposits. In the past, banks have from time to time egged on the RBI to raise savings bank deposit rates only to go back on bended knees to rescind the increase.
With all the other deposit rate controls having been abolished, a removal of the savings bank interest rate control is inevitable. While altering the present interest rate regime on savings bank accounts, the RBI has to act with great finesse so as to not to rock the boat. Equally, the RBI cannot continue the present interest rate control in splenetic isolation.
With term deposits in clusters of Rs 1 or multiple option deposits without penalty for early withdrawal, the concept of term deposit has changed. While new private sector banks will continue to outpace public sector banks in the increase in deposits, they are unlikely to destabilise the operation of PSBs which have size and reach in their favour. The new private sector banks would, however, provide increasing competition to PSBs which in itself would be highly desirable.
What then would be the downside risk of a total removal of savings bank deposit rate control The real danger is that PSBs would enter into a major interest rate war among themselves in an endeavour to garner more savings bank deposits even though the initial trigger could be the private sector banks. The RBIs institutional memory is unlikely to forget the 1985 episode when banks recklessly increased rates on 15 days deposits and were indirectly paying interest on current accounts.
As 85 per cent of savings bank deposits are interest bearing, the fixed rate of 4 per cent on these deposits translates to an effective rate of 3.4 per cent. While the savings bank interest rate control has to ultimately go, it is important to so phase the deregulation process that the system is not destabilised. The present nominal interest rate on savings bank accounts was fixed when the structure of term deposits was at least two percentage points higher than the present structure of rates. There would, therefore, be a case for lowering the savings bank deposit rate from 4 per cent to say 3.5 per cent.
While this would be an easy solution, it would be a status quo and as far as the system of controls is concerned, the deregulation process would not have been initiated. A better solution would be to alter the present fixed rate of 4 per cent into a rate of not exceeding 4 per cent. This is the characteristic way in which the RBI initiates the deregulation process. In the current milieu of a call for softening interest rates, some banks may be emboldened to gradually reduce the savings bank deposit rate below 4 per cent.
The fear is that the bank that drops its savings bank deposit rate below 4 per cent would experience an exodus of deposits. This is an erroneous perception. Depositor loyalty to their banks is strongest among savings bank account holders. How often do savings bank account holders switch banks on grounds of a bank being weak or the depositor has experienced a problem while operating the account Despite some banks not matching others in providing facilities, depositors rarely change banks.
Another alternative would be to set out the rate as a range, such as between 3.5 per cent to 4.5 per cent. This would no doubt fly in the face of the authorities predilection for softer rates and not be acceptable to them. There are many PSBs which are savings banks qua savings banks and it would make sense for these banks to offer a slightly higher rate than most banks on savings accounts and yet see a drop in their average cost of deposits.
There is a general hue and cry when banks raise the minimum amount for a savings bank account. The new private sector banks and the foreign banks put the threshold at a fairly high figure of Rs 5,000 or more and thereby seek out the creamy layer of savings bank account holders. While there is no RBI control on the minimum amount in a savings bank account, there is always the fear of the RBI/ministry of finance frown if the minimum amount is raised by PSBs. The RBI must proactively encourage PSBs to periodically raise the minimum amount in savings bank accounts. Many banks still adhere to a minimum balance of Rs 500 for a savings bank account. This is ridiculously low considering that aggregate deposits of scheduled commercial banks have increased from Rs 1,92,500 crore in 1990-91 to a staggering Rs 10,89,900 crore in 2000-01 ie more than a five fold increase. The very small deposits would, quite rightly, veer to the Post Office deposit system, while banks would pick up deposits above the threshold. It is stultifying to hold down banks to fixed nominal values when the entire system undertakes inflation adjustment.
To sum up, the RBI should give up its hesitancy to start the deregulation process on the savings bank interest rate. If the RBI does not move with the times, the market will devise novel means of circumventing control it indeed already has with cluster deposits, sweeping accounts and what have you.