On 28 April 2011, the Reserve Bank of India put out a discussion paper titled “Deregulation of Savings Bank Deposit Interest Rate”, which is available at rbi.org.in/rdocs/Content/PDFs/DPS270411F.pdf. This article reviews the paper and responds to the five questions posed in it.
According to the RBI paper, the savings bank deposit interest rate (SBDR) is the only interest rate that remains to be deregulated. As there are other administered interest rates, this is not entirely accurate. For instance, the small savings, pension and provident fund schemes of the central and state governments carry interest rates which are not market determined. Nevertheless, this is a welcome initiative.
To put the suggestion to deregulate the SBDR in perspective, the paper recapitulates that deposit and loan interest rates were almost fully deregulated by the late 1990s. Subsequently, interest rates for small loans up to Rs 2 lakh and Rupee export credit were liberalised in stages by July 2010. However, RBI has continuously determined the SBDR since March 1978. It was 6 per cent per annum in 1992 and was gradually reduced to 3.5 per cent by March 2003. Since then the SBDR remained at 3.5 per cent till RBI raised it to 4 per cent on 3 May 2011.
In March 2009, savings bank deposits totalled about Rs 90,000 crore. As of the same date, 84 per cent of these accounts were owned by households and 32 pe r cent were held in rural or semi-urban areas. Such savings bank accounts constituted 26.8 per cent of the household sector’s financial assets and added up to 22 per cent of total bank deposits. Evidently, this category of scheduled commercial bank accounts is significantly large, both in absolute, and relative terms.
The paper points out that since 2004 the SBDR has been nearly always below the reverse repo rate, deposit rates for maturities of three months or longer and negative in real terms (reverse-repo rate, the rate at which banks park funds with RBI, is currently 6.25 per cent). Savings bank depositers usually hold a substantial fraction of their account balances over periods longer than three months. These account holders are perhaps not sufficiently aware about higher interest rates on fixed deposits. Alternatively, they are willing to accept a lower interest rate to be able to withdraw funds when required.
Of the five questions on which RBI is seeking a feedback, the first is whether this is the right time to deregulate the SDR. It is likely that deregulation of the SBDR will increase competition among banks for these accounts thus raising this interest rate. Further, if this interest rate is appreciably higher, greater volumes of funds could be attracted to such accounts. On the down-side, banks would compensate themselves by raising lending rates, limiting withdrawals and stipulating minimum balances. However, RBI could prescribe a ceiling for minimum balances. All things considered, the response to this question has to be a resounding yes.
The second and third questions are whether the SBDR should be deregulated in phases with a minimum floor and how can the interests of “senior citizens, pensioners and small savers particularly in rural and semi-urban areas” be protected. Phased deregulation would delay the end objective, which is to enable account holders to receive a market-based return. If the SBDR were to dip occasionally to low levels, there are more direct ways of helping weaker sections rather than distorting interest rates.
The fourth question is about possible “intense competition among banks” and potentially risky asset-liability mismatches. It could be argued that banks can land themselves in unsustainable situations by offering excessively high interest rates for such deposits. Banks invariably borrow short and lend long — that is their basic business model. Consequently, if asset-liability mismatches were to trend upwards post SBDR deregulation, banks would be expected to limit their duration (maturity) mismatches and hedge interest rate risk using interest rate futures and interest rate swaps. However, liquidity in the Indian interest rate futures market is negligible. As regards over-the-counter (OTC) interest rate swaps, the principal benchmark used for the floating leg is the overnight Mumbai inter-Bank Offer Rate (MIBOR). This is too short a maturity for interest rate resets. Consequently, liquidity in the Indian interest-rate swap market for maturities above one year is relatively very low.
RBI and the Securities and Exchange Board of India need to coordinate their efforts to develop the interest rate futures market by increasing liquidity in the underlying short maturity government securities markets. Further, the settlement of OTC derivatives should be guaranteed through central clearing platforms including exchanges. RBI has specified that at least one of the counterparties for OTC derivatives has to be regulated by RBI and this excludes stock brokers. One way to increase the number of market participants is for brokers to be concurrently regulated by RBI for their activities as counterparties or market-makers in OTC markets.
The fifth question is about the frequency of withdrawals and whether banks should offer higher interest rates if cheque-book facilities are not available to savings bank account holders. Decisions on such trade-offs should be determined by banks on the basis of competition among them.
In the 11 May 2011 edition of the Business Standard the MDs of HDFC and YES banks took opposing positions on deregulating the SBDR. HDFC takes the view that there is no “free lunch” and if savings deposit rates go up, lending rates, maintenance and other charges would rise commensurately. YES bank is of the opinion that a market-based rate would be fair to this category of savers. Additionally, this could induce households to transfer some more of their huge cash balances to the banking system. Others have commented that recourse to external commercial borrowings would go up if domestic lending rates were to rise. A counter argument is that external sources of funding are already part of the competitive lending process in India and there are guidelines on maturities and caps on overall volumes.
To summarise, it is likely that various banks are making their behind the scenes moves for RBI to go slow on deregulating the SBDR. It is to be expected that banks will try to retain this subsidy of offering negative real interest rates on savings bank deposits while charging competitive rates for housing and other loans. However, this subsidy is paid for by the middle-class or lower income savers and it is high time it should be eliminated.
(The author is India’s Ambassador to the European Union, Belgium and Luxembourg. Views expressed are personal)
