Savings bank interest rates fall: how households are affected by loss and lenders gain

Those which were offering 5-6% have also brought down their rates by a similar amount. (PTI)

An interesting development in the banking sector that has not provoked much discussion is the lowering of savings bank interest rate by 50 bps by a number of banks. It was spearheaded by SBI; and quite expectedly, other banks have followed. Most banks that were offering 4% interest on these deposits would now pay only 3.5%. Those which were offering 5-6% have also brought down their rates by a similar amount. This action was contrary to the action taken by banks in 2011—even while RBI deregulated interest rate on savings deposits in October 2011, the response of some banks was to increase rather than decrease it. In fact, the rate had gone up to 7% for some banks above a minimum threshold of deposit level. Now, for the first time, banks have lowered the rate. Such an act has several interesting implications.

The first is that when one bank does take such action, others follow. There has always been an oligopolistic approach towards interest rates in the country even after deregulation, as all banks normally end up working in unison as the invisible hand guides them. There could be differences in interest rates offered on different tenures of bank deposits, but such decisions are guided more by their respective requirements of funds to match asset tenures. This holds especially for public sector banks (PSBs), where it may be difficult to distinguish the interest rates offered on deposits.

Second, households appear to be very sticky when dealing with banks. When some private banks offered a rate of 200-300 bps higher on savings deposits, there was no migration from the existing banks to those offering higher rates. This means that households are ‘lazy’ and do not readily react to incentives on the deposits side. A reason could be that there is a long-term association with a bank branch, which makes them reluctant to swap deposits across banks when rates offered are different. In addition, the process of shifting over is cumbersome as it involves opening new accounts with all the compliances in place. Banks are hence able to exploit this frailty of consumer behaviour as individuals are not rational here. Interestingly, for consumer goods, people tend to be very discerning about price, but when it comes to bank deposits, they really do not care much. Even service quality often does not matter, as once any bank becomes a habit, nothing else matters.

Third, banks on the whole can save considerable amount of money by continuously lowering the rate. As almost 25% of deposits are in these accounts, 50 bps cut in rates would save around Rs 12,500 crore if done across all banks. If they further reduce rates by another 50bps, then the total savings go up by Rs 25,000 crore, which will help to strengthen their profit and loss (P&L) account. As an extension, this can be used for making provisions on NPAs and clean up their balance sheets faster. Customers really don’t have a viable choice, or choose not to change over banks, just like they are indifferent when banks charge for virtually every normal banking service like cheque books and ATMs beyond a threshold. Here too, there is little differentiation across banks in terms of price.

Fourth, a logical question to pose to banks is that if, on their own volition, they have successfully lowered the savings bank rate with other things being constant, they could also do the same on term deposits and not wait for RBI to lower policy rates. As an extension, this can be stretched to the lending side too. It is significant that banks have been lamenting that RBI has been intransigent in its stance on monetary policy and, therefore, as a corollary, are not in a position to lower rates. Industry, too, has been dissatisfied when RBI does not lower interest rates every two months. By unilaterally lowering rates on savings deposits, banks have actually acted independently. This, in a way, is good, as they have taken a decision jointly to go by their instinct, albeit inadvertently.

It should be remembered that the repo rate enters the formula for calculating the base rate or the Marginal Cost of funds-based Lending Rate (MCLR) purely on the basis of the quantum borrowed or lent through these windows. For every Rs 1 lakh crore of funds in the repo or reverse repo reservoir—including daily and term instruments—the rate involved for 50 bps is just `500 crore, which is minuscule as the total interest income of all banks in 2015-16 was about `10 lakh crore. The amount is not really significant and, therefore, logically, banks should be able to take whatever action they feel is appropriate rather than wait for RBI to lower rates.

Fifth, at an ideological level, such decisions also have an impact on the efficacy of monetary policy. As long as banks respond to the repo rate change, which is what RBI calls the transmission mechanism, monetary policy will be effective. If banks continue to act on their own and independent of the RBI policy direction, then monetary policy impact becomes weaker and, at the theoretical limit, will cease to matter (which is unlikely as banks would never exceed the thresholds).

Globally, the rate paid on similar accounts is much lower and would not be more than 20-25% of the fixed deposit rate with a tenure of one year. Based on this norm, the savings bank interest rate could be lowered further, which will be good for banks, though not so good for customers. If a fixed deposit gives a yield of 6.5-7%, then at 3.5% the savings bank rate is still 50% of the former. Individuals would need to consider investing in very short-term liquid options of mutual funds if the amounts are large, as there is significant flexibility here, with withdrawals being possible with a lag of a day. Account holders could also try using the term deposit route with a sweep-in facility to ensure that only a minimum amount is kept in this account and the balance earns a higher rate. Customers have to re-evaluate their options and change their mindsets to optimise their returns.

Interestingly, post office savings accounts offers 4% without any limit and hence could become attractive, provided savers are flexible. In the past, banks have pointed out that they have not been in a position to lower deposit rates as post office savings and small savings offered higher rates. Quite clearly, it appears, they are out of this syndrome.

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