Even in a fast liberalising Indian economy since the early 1990s, regulation of most sectors continues to be the holy cow, with banking being even more so. However, banking has been fairly deregulated in the last two decades and the last vestige of regulation remains in the savings bank (SB) rate only. Recently, there have been a lot of discussions to free the SB interest rates also but most of the argument in favour of this deregulation seems to suggest it for the sake of deregulation only.

Deregulation?

The SB deposits play a big role in pushing down the overall cost of funds for the banks. At a time, when the central bank has upped the ante on repo rates nearly 10 times in one year, banks are at their wits' end in keeping their cost of funds low. Deregulation of SB interest rates is being advocated on the grounds that the real rate of return on SB deposits, at present, is negative.

Therefore, in tune with the present inflation rates, SB rates should also rise and that this can be achieved by deregulation – so goes the argument. But, unless it is raised by about 500 basis points with inflation at around nine per cent, real rate of return on SB deposits will continue to be elusive.

This apart, the suggestion that SB deposits should provide real rates of return is misplaced. Over the last quarter of a century, the SB interest rates in this country have been administered in a band of 3.5-5. Considering the fact that inflation has never been consistently under five per cent, it is clear that this segment of deposits never provided a real rate of return.

The Reserve Bank of India (RBI) has estimated inflation at around nine per cent for the first half of the current financial year. At present, fixed deposits with tenors up to 18 months are earning around 8.25% p.a. So, as oil and food led inflation races away, even fixed deposits will not provide real rate of return, as has been the case many times in the past too, such as the 1991 crisis, when inflation had touched around 17 per cent.

Therefore, the argument SB deposits should provide real rate of return is just not tenable.

Further, the SB product is not exactly placed to maximise returns. Consumers of these services park their floating funds for use over the short or medium term. It is the service and the ease of operations that drives them into parking their funds in SB and not the rate of return.

Rural, Semi urban markets

Consumer behaviour in use of SB deposits also differs in terms of geography as well as demography. The rural and semi urban markets are more sensitive to interest rates while the metro and urban depositors are less so. The rural markets see fixed deposits in banks as the safest way of parking funds. The flight of SB balances to fixed deposits, with or without deregulation, may be more pronounced in the hinterlands.

urban and metro

In the urban and metro markets, people park funds in SB Accounts more for using them for monthly expenses, equity investments and online purchases and, therefore, keep the account well funded. This is particularly true of the yuppie group with higher disposable incomes and its propensity to indulge in impulsive purchases at point of sale terminals using debit cards. Therefore, consumers associate certain nature of uses (in line with their lifestyles) with the SB account and not necessarily higher rates of return alone.

Again, if banks are forced to raise the SB interest rates either on grounds of competition or on account of it getting pegged to a reference rate which is high, then, banks will have to make good this amount elsewhere.

Since April 2010, SB deposits are paid interest on their daily balances pushing up their cost of funds possibly by 0.5 per cent (or higher) and the recent increase of 0.5 per cent from 3.5-4 per cent, cost has increased by one per cent or more for the banks in about 12 months.

transaction charges

In this scenario, a further increase in SB interest rates, on account of deregulation, will almost certainly lead to transaction charges. The concept of “users pay for services” is still not well set in India and such a change may face resistance from depositors, as many of them are, anyway, not earning much by way of interest.

It is true that there has been no high cost rate war consequent upon the deregulation of term deposit rates and that the market has matured. But, if SB deposit rates are deregulated, banks whose current account savings account (CASA) deposits' proportion is low in their total deposits, might quote aggressive rates to build a strong SB kitty.

CASA–driven

While every bank today is CASA–driven, the new generation private sector banks, being the pioneering protagonists of CASA led growth, may find the going tough by way of loss of SB deposits to other banks quoting more or face the compulsion to raise their own SB rates.

However, those Banks that quote high might face a double whammy – if the SB portfolio does not grow significantly, they will end up pushing their cost of funds. So, banks which feel that they would be better off if this interest rate is deregulated and pegged to some reference rate (reverse repo rate as suggested by most) would do well to think again.

If the RBI is now sitting on the horns of the Hamletian dilemma of deregulation or administration of SB interest rates, the one simple question that they have to ask themselves before deciding in favour of deregulation is this: Is it at all necessary to open this Pandora's box now? Does not mythology tell us that it could well lead to chaos? SB interest rates, therefore, are best left administered and where they are even if it sounds unfashionable at a time when most have fallen in line, if not in love, with the idea of free markets.

(The writer is Vice-President, Axis Bank. The views expressed are his own and personal.)

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