core sector communique

RBI favours freeing savings bank rates

Your savings bank (SB) accounts could soon start earning anywhere between 4 per cent and 6 per cent per annum. That is much more than the 3.5 per cent per annum that you have been getting for the last one year after the daily product method of calculation was introduced. It was effectively about 2.7 per cent (when interest was paid on the minimum balance in a month) for the seven years before that.

But just be ready for another possibility. Savings bank interest rates could also dip much lower than what prevails currently in a situation where banks are flush with funds.

All this will happen if SB account rates are deregulated. A discussion paper on the subject has been put out by the Reserve Bank of India (RBI) today.

Deregulation of savings rate has been hinted at for the last several years. But this was deferred for many years because it was felt that a substantial part of such deposits was held by low-income households in rural and semi-urban areas. But other deposit rates (term deposits) were systematically deregulated and freed from administrative control over the last two decades. SB account deregulation is the last in the series of such steps.

SB rates, which were once as high as 6 per cent per annum, were brought down to about 3.5 per cent in March 2003 and have remained stagnant at that level ever since. This has hurt the interests of savers in an inflationary environment where their returns have been negative. Deregulation of savings rate will foster competition among banks — push up savings bank rates, help introduce some product innovations and benefit depositors.

Higher interest rates may push up costs for banks that were hitherto used to relying on CASA (current and savings accounts). There has been fear of asset-liability mismatches because of unhealthy competition, but the discussion paper points out that the experience of deregulation of term deposits doesn't suggest that things will get out of hand.

Importantly, for the RBI, it will help improve transmission mechanism , that is, it will get banks to act in the way that the RBI wants them to move when it alters its policy rates. Currently, the presence of one regulated rate (SB rate) — which doesn't move — has hampered this objective slightly. As the discussion paper notes, other countries have had a positive experience with deregulation, which has also contributed to increased financial savings.