The saga of regulation of interest rates in India and its subsequent deregulation is a fascinating story spread over nearly 50 years. In the 1960s, there was a major deposit rate war among commercial banks and, during the internecine battle, banks pleaded with the Reserve Bank of India (RBI) to regulate deposit rates. The RBI was first inveigled into regulating select deposit maturities and, subsequently, the banks wanted all term deposit rates to be regulated by the RBI. Simultaneously, lending rates were progressively regulated.
In the 1980s, a tentative attempt was made to deregulate short-term deposit rates subject to a ceiling. This experiment failed as banks were so used to regulation that they all jumped off the cliff and the experiment had to be abandoned. During the general deregulation of interest rates in the 1990s, the savings bank rate remained the last bastion of interest rate regulation. For the past 30 years, every Governor contemplated deregulating the savings bank rate, but backed off from taking the plunge.
The RBI Governor, Dr D. Subbarao will go down in history for being the one to ultimately deregulate the savings bank rate. Kudos to the RBI for leading from the front. One fervently hopes that the RBI will do a bit of hand-holding to ensure that banks do not go berserk. If the deregulation succeeds, Dr Subbarao will receive the blessings of millions of savings bank depositors.
Equitable returns
While deregulating the savings bank deposit rate, the RBI has added a somewhat intriguing proviso. For deposits up to Rs 1 lakh, a bank would have to provide a uniform rate, irrespective of the amount, while for larger deposits banks have been allowed to fix different rates for different amounts. Such a prescription does not appear desirable.
Some banks already have sweeping accounts, multiple option accounts and, in some banks, term deposits of any maturity can be withdrawn without any penalty.
In this context, it would have been preferable if each bank was permitted to offer a single savings bank rate, irrespective of the amount. The basic objective of this reform is to ensure that small depositors earn an equitable rate of return. The bulk of savings bank accounts are by small holders and their balances are invariably stable. Furthermore, in the context of financial inclusion, small depositors need to be encouraged.
There is an erroneous view that the deregulation will raise the cost of funds to banks and, thereby, impinge on their net interest margin (NIM). This conclusion is faulty as it is based on comparative statics. In a dynamic context, banks may, in fact, see an improvement in their NIM. If a bank has an unusually low proportion of savings bank deposits and a very high proportion of high-cost term deposit maturities, it can benefit by offering higher rates on savings bank deposits. It should be incumbent on banks to so fix their rates that they attain reasonable NIM.
‘Yes' strategy
One of the banks with a very low proportion of savings bank deposits — YES Bank — has fired the first salvo by raising the savings bank rate from 4 per cent to 6 per cent for all savings bank depositors. This is a right strategy for YES Bank. Anticipating the deregulation, the State Bank of India, well before October 25, sharply raised the shorter-end of term deposits up to 90 days to 7.5 per cent. What the SBI does on the savings bank deposit rate in the next few days will be a pace-setter for other banks.
The RBI should, as part of its moral suasion, caution banks not to jeopardise the NIM in the process of determining their own savings bank deposit rates. As part of transparency, the RBI should insist on a uniform quarterly rest by all banks so that depositors can easily assess the rates offered by different banks. The savings bank depositors are the most loyal in the firmament and there is no danger of any major exodus out of individual banks because of small variations among banks.
Migration of deposits
Of course, if a number of banks offer high savings bank deposit rates and several offer very low rates, there is the possibility of migration of deposits. But, equally, banks which offer unusually high savings bank deposit rates will be inflicted with significant erosion of their NIM. Thus, there are enough checks and balances in the system and the deregulation of the savings bank deposit rate is most likely to be a great success.
The deregulation of the savings bank deposit rates was long overdue and it is to the credit of Governor Subbarao that he has taken this bold measure.
Tail-piece : The savings bank deposit deregulation has overshadowed all other measures, including the repo rate increase by 0.25 per cent. One fervently hopes that the RBI does not have to rue its explicit guidance that future increases in policy rates in the ensuing period are unlikely.
(The author is an economist. >blfeedback@thehindu.co.in )