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Savings rate deregulation: what to do

Effective 25 October, the Reserve Bank of India (RBI) deregulated the savings bank account interest rate. Though banks may offer higher interest on savings, parking surplus money in liquid mutual funds is a better option. At a glance: deposits vs funds

india Updated: Nov 11, 2011 22:46 IST

Your bank balance is about to get a boost. Effective 25 October, the Reserve Bank of India (RBI) deregulated the savings bank account interest rate. In simple words, every bank is free to fix the interest rate it wants to pay on savings account deposits, compared with the standard 4% that they were mandated to pay till now.

Soon after the deregulation announcement, three private banks raised savings account interest rate to 6% per annum for balances above R1 lakh and 5.5% for deposits less than Rs 1 lakh.

The RBI has told banks to pay a uniform rate to all customers having savings account balance of up to Rs 1 lakh. For balances above Rs 1 lakh, banks are free to choose interest rate bands.

What this means for you

Many financial experts believe that it’s unlikely that customers would switch banks anytime soon, purely on account of higher interest rate. Moreover, if you have a salary account or your bank account gets debited every month towards your loan commitments or even for utility bills such as electricity or telephone bills, changing a bank account can get tedious. Also, the average Indian consumer has till now shown little interest in moving funds from one bank to another.

This could be on account of long-standing relationships or simply the lack of any real need to do so. “High networth individuals anyway move surpluses to liquid funds,” said Pawan Joseph, vice-president, Motilal Oswal Wealth Management. “In the case of retail customers who are not conscious about wealth management, a very small amount will shift. Moreover, the relationship with the bank and tied-in financial transactions are difficult to change.”

However, not everyone agrees. “If other services are the same, customers will consider the benefit of higher savings rate,” said KVS Manian, president-consumer banking, Kotak Mahindra Bank.

Let’s calculate how much a 150 basis points (one basis point is one-hundredth of a percentage point) hike in savings rate means for a Rs 50,000 balance. In a year it amounts to an additional interest of Rs 750, or Rs 63 more per month, before tax. If your bank hikes savings rate by 100 bps compared with 200 bps by another bank, and you switch banks, then you stand to earn only R83 more every month for a bank balance of Rs 1 lakh. Not a large incentive to move your account, you’d say.

Do they match liquid MFs?

Rising interest rates for the past two years have meant that your liquid funds’ returns have been attractive. Between June 2011 and now, liquid and ultra short-term funds have offered about 7-7.5% return per annum. Further, dividends in liquid funds and ultra short-term funds are taxed at 27% and 13.5% respectively, compared with 30.9% at which your savings bank account interest is taxed, assuming you are in the highest tax bracket. A back of the envelope calculation shows that investments in liquid and ultra short-term funds would outperform saving bank interest rate if you are in the highest tax bracket.

Should you, then, continue with your systematic transfer plan (STP; putting a lump sum in liquid or ultra short-term fund and then switch systematically to an equity fund)? “It’s a smarter strategy to remain with a liquid fund and do STP in an equity fund,” said Puneet Pal, senior vice-president and fund manager, debt, UTI Asset Management. “Putting money in liquid funds give higher returns to investors compared with putting money in bank savings. It’s easier also.”

Select banks join race

Not all banks have raised rates. Banks that have raised rates such as Yes Bank, Kotak Mahindra Bank and IndusInd Bank, have relatively fewer savings accounts and hence, may be looking to attract customers who are getting lower interest rates. If and when other banks will follow is yet to be seen.

“This is a good reform, but it will take time to play out,” said Pathik Gandotra, head, equities, IDFC Securities. “Public sector banks are unlikely to raise rates as there is no reason or scope to do so.”

Large public banks have said that they aren’t in a hurry to raise rates. For State Bank of India, which has the largest deposit base, a 100 bps increase in savings rate can potentially increase their annual interest expense (for the rest of the fiscal) by 4-5% or Rs 1,400-1,500 crore.

This can translate to a 15 bps or so reduction in net interest margin (NIM), if loan rates don’t rise. For a bank, NIM is essentially the difference between the total interest earned and total interest paid as a percentage of total assets and it shows the average margin a bank makes by borrowing and lending funds.

While this reduction may not be significant in itself, given the difficult economic environment, it will pinch the large banks. Even for private banks such as ICICI Bank Ltd and HDFC Bank with large deposit base, the effect on annual interest expense (for the rest of the fiscal) can potentially be between 3% to 5% increase.

Passing cost to customers

It's a given that banks that raise savings rate and incur additional costs are unlikely to absorb it and will pass it on to consumers. Banks paying higher rates will offer minimal benefits while low savings rate bank accounts might offer more benefits, experts said.

What this means is that if you are getting 6% interest on your saving account, keep an eye out for the need to maintain a higher minimum balance, higher charges for cheque books, “outstation cheque” clearances, inter-bank transfers and so on. “If banks are forced to raise rates there are going to be charges for everything,” said Gandotra. “Cost of service will go up as large banks will try to match each other. This hike (in savings rate) is not going to lower profit.”

What should you do?

Don’t be perturbed when you see your bank offering a 150-200 bps lower return on your savings account. If you have to open a new account then don’t take only the savings account rate into consideration, but look at the services it offers and charges.

Also, remember that a deregulated saving account rate means that if rates can be higher now they can potentially be lower in a different market environment. Just like fixed deposit rates move up and down depending on policy rate, the savings rate will also adjust.

We suggest you stick to your liquid and ultra short-term funds to park your surplus cash. At the same time, a deregulated savings rate should spice up your savings bank account.

First Published: Nov 11, 2011 20:22 IST