CIRCUIT BREAKER. End banks’ monopoly over retail savings

Why do Indian banks get such kid-gloves treatment from stakeholders? The Government, well aware of the role played by bankers in creating the mountain of NPAs, has been shrinking away from hard decisions such as privatising the worst-performing banks or denying capital to them. The RBI, despite grumbling periodically about banks not passing on rate cuts and ‘lazy’ banking, has been loath to penalise individual banks for such infractions.

Depositors, despite constantly being taken for granted on service quality, costs and interest rates, continue to rely overwhelmingly on banks to park their savings. India’s largest bank has just trimmed its interest rate from 4 per cent to 3.5 per cent on its savings accounts, citing high ‘real returns’. That’s conveniently forgetting that depositors have gamely accepted negative real returns on their savings accounts for much of the last decade!

In fact, the real reason why the Government and the RBI give banks a long rope is that they are such large custodians of public money. RBI data on household savings tells us that bank deposits grabbed 42 per cent (₹6.2 lakh crore) of the ₹14.9 lakh crore of incremental financial assets added by Indian households in FY16. That was nearly twelve times the assets that went into small savings schemes, six times the money added to shares and mutual funds, and three times the assets salted away in pension and provident funds.

As of July 2017, Indian banks sat on a mammoth ₹106 lakh crore in demand and time deposits, over 60 per cent of which belongs to ordinary households. Clearly, with this kind of public money in its coffers, the fortunes of the banking system are closely intertwined with consumer and investor confidence. That’s why both the Government and the RBI are so wary of doing anything that can cause even the faintest of tremors in the banking system.

But with banks now facing a problem of plenty and actually looking to disincentivise depositors, the time is just right to cut this Gordian Knot. The Government should seize this opportunity to open up alternative savings avenues to retail folk, so that they are no longer over-dependent on banks.

Small savings schemes run by India Post at one time offered a popular alternative to banks. But a steady reduction in tax benefits, sharp cuts in interest rates and creaking service infrastructure have decimated their popularity with retail savers in recent years. Therefore, despite the unparalleled distribution reach of the post office network, small savings manage less than a tenth of the assets cornered by banks.

With 1.4 lakh branches that reach deep into the rural hinterland, India Post can emerge as the preferred custodian of savings for low-income earners in India’s smaller cities and towns. To induce these savers to consider it, the schemes will need some tweaks. Their features need to be greatly simplified. The current practice of subjecting small savings schemes to quarterly interest rate resets based on prevailing market yields is terrible. Instead, it would be best if the Centre moved back to fixed rate regime on these schemes, with a constant mark-up over long-term inflation rates. Resets in the small savings rates should be effected only when there are significant structural changes in inflation rates. The Centre must also waive income tax on the interest from the post office savings account. A monetary ceiling on individual investments in each scheme can ensure that affluent savers don’t reap undue benefits.

The quality of customer experience that the small savings desks of India Post deliver also needs to be vastly improved. Disinterested staffers and ill-equipped agents need to be replaced. With India Post already on an ambitious project to overhaul and computerise its branches, this isn’t such a tall order.

If the subsistence saver needs savings avenues that will preserve his capital and minimise market risk, the affluent saver needs exactly the opposite. Middle and high-income earners who use bank accounts as a parking ground for their monthly pay cheque may well be willing to take on market risks, if it means earning superior returns. Money market mutual funds, which pool retail money and redeploy it in money market instruments, provide the ideal solution to this.

Presently, the Indian mutual fund industry offers a long line-up of liquid and short-term bond funds, but very few designated money market funds. Liquid funds take on corporate bond exposures (which carry credit risk) and are mainly designed for corporate treasuries and institutional investors. They are also subject to high rates of tax on their dividend distribution (28.3 per cent at source) and capital gains (at the slab rate if withdrawn within three years).

The mutual fund industry can be prodded to launch wholly retail-investor focused money market mutual funds which invest mainly in sovereign bonds. To ensure that they offer a credible alternative to banks, these funds need to enjoy the same tax breaks as savings bank accounts.

A big reason why Indian households pour so much money into banks is that safe savings avenues are in short supply. The safest fixed income investment in any economy is the sovereign bond. India certainly has no dearth of supply of sovereign bonds, given that the Central government borrows over ₹3-4 lakh crore from the market by auctioning government securities every year. These g-secs come in tenures from 91 days to 30 years and are sold by the RBI. If made available to the retail investor, they could expand the menu of safe options available.

While the RBI has been talking for years about encouraging retail participation in the g-sec market, the effort has been a non-starter so far. This is because access to the g-sec market is restricted only to RBI-designated primary dealers, which are usually banks or their subsidiaries. As retail investors don’t deal with primary dealers for any of their other investments (stock market investments are routed through depository participants and stock brokers), one has to specifically open an account with a primary dealer to acquire or transact in g-secs. In fact, most retail investors are not even aware that they can directly own g-secs.

This lack of retail access creates ample opportunity for lazy banking. Banks get to pocket a hefty spread simply by sourcing CASA (current account savings account) deposits at 4 per cent and lending it to the Government at 6-7 per cent. When banks are in a risk-averse mood, as they have been this past year, nearly a fourth of their deposit base is deployed in this fashion. If the g-sec market could be disintermediated and g-secs be made available to retail investors through mainstream investing platforms, they could be quite a hit with retail investors.

It is time Indian banks worked harder for the saver’s money. Is the Government ready to give them a taste of competition?