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RBI move to hold on to bank deposits may hit interest rates

business Updated: Nov 28, 2016 10:27 IST
Beena Parmar

Passers by are reflected on the logo of the Reserve Bank of India (RBI) outside its headquarters in Mumbai.(AFP)

The Reserve Bank’s move on Saturday of retaining with it all cash deposits with banks made between September 16 and November 11 is likely to result in a marginal rise in costs for banks, as about ₹3.5 lakh crore of money will flow out to the RBI from the surge of deposits made in the wake of the November 8 demonetisation.

This could also lead to a delay in lowering of interest rates, against popular opinion that the central bank is likely to cut rates in the December credit policy.

“There would be marginal impact on banks and hence the costs could rise as they earn no interest on the money kept with RBI, but will have to pay interest on deposits. Banks may cut rates, but (only) after this move is reviewed on December 9,” NS Venkatesh, executive director, Lakshmi Vilas Bank told HT.

Any deposit in banks would attract interest rate of at least 4% interest to be paid to the account holder, thereby increasing costs to the bank.

On Saturday, RBI hiked cash reserve ratio (CRR) to 100% of all deposits for the September 16-November 11 period. The central bank will review this temporary measure on December 9.

Venkatesh said the move was done as the yield (interest) on the government bonds, which fell sharply, was distorting neutral interest rates. The interest on 10-year benchmark government bond fell to 6.18%, which is below RBI’s policy rate of 6.25%.

As per RBI estimates, the move will draw out approximately ₹3.5 lakh crore worth of deposits. In the first eight days after November 8, banks received ₹5.44 lakh crore in deposits.

“This is intended to absorb a part of the surplus liquidity (cash) arising from the return of the specified (old ₹500 and ₹1,000) banknotes to the banking system, while leaving adequate liquidity with banks to meet the credit needs of the productive sectors of the economy,” RBI said.

Since the move is a frictional liquidity measure, the deposit increase can impact market interest rates.

Due to surplus liquidity in the wake of demonetisation, some banks have already reduced deposits rates in the range of 15-50 bps (0.15-0.50%). September alone saw an aggregate addition of Rs 5.98 lakh crore in deposits over that in August 2016, hitting an all-time high of Rs 102.08 lakh crore.

Finance minister Arun Jaitley said the spike in deposits was primarily on account of payout of arrears of 7th Pay Commission. An SBI report said about Rs 45,000 crore could be in the form of the 7th Pay Commission arrears, while a large part of the residual Rs 85,818 crore, could have come from the Income Disclosure Scheme that ended in September 2016.

“Alternatively, given that IDS attracted a penalty of 45%, people may have preferred to disclose these as forceful deposits/advance tax payments so as to pay a tax of 30% and not 45%,” SBI said. Some experts also suggested that a lot of deposits arose due to savings ahead of the festive season.