RBI might deregulate savings interest rate

By BankBazaar.com | July 8, 2010

Recently, RBI Governor, D Subbarao has indicated that RBI is in favor of deregulating the savings bank interest rate, which is currently fixed at 3.5% p.a. for deposits up to Rs. 2 lakh. Deposits over Rs. 2 lakh are currently deregulated allowing banks to fix their own rate.

Interest on savings bank account is the only type of deposit which is still regulated by RBI. This is a step in the direction of attaining the objective of financial sector reforms.

Banking space is on the cusp of changes with a revision in the methodology of interest rate calculation on savings account from 1st of April, 2010 and now with base rate scheduled to replace prime lending rate kicking in from July 1st onwards.

Recently, RBI Governor, D Subbarao has indicated that RBI is in favor of deregulating the savings bank interest rate, which is currently fixed at 3.5% p.a. for deposits up to Rs. 2 lakh. Deposits over Rs. 2 lakh are currently deregulated allowing banks to fix their own rate.

Interest on savings bank account is the only type of deposit which is still regulated by RBI. This is a step in the direction of attaining the objective of financial sector reforms.

Saving bank deposit is an important component of any banks deposit base (also part of CASA) because it comes at a low rate of interest i.e. lower than every other source of finance (bulk deposits, fixed deposits) excepting current account deposits. If RBI goes on to deregulate interest on savings bank account, it will increase competitiveness in the banking space, as banks with low savings bank deposits, will find this an excellent opportunity to build their saving deposit base, by attracting investors to it through attractive rate of interest in comparison to other banks. This would benefit customers because they will end up getting a higher rate of interest.

Having said that, any increase in interest rate on savings bank account will certainly impact the margins of banks if it is not accompanied by an increase in lending rates which no bank will like to settle in for. So while there may certainly be an increase in savings bank interest rate to attract deposits, (because even with an increase in interest rate, it may still end up being the lowest cost source of finance) the differential will be under check. Also, the repo rate, i.e. the rate at which banks borrow from the RBI, will be an automatic cap for the interest on savings bank because it does not make sense to borrow at high cost from saving account holders when the same is available from RBI at 5.25% currently. Thus, the rate of interest offered to customers will be a function of the liquidity conditions in the market, the cost structure and the need for funds.

Just as fixed deposits- a product whose interest rate is unregulated by RBI, is being offered by various banks at varied rates of interest depending on the cost of funds and need for funds, similarly, banks will be able to offer different rates depending on their objective and cost structure.

As it stands today, implementation is a long time away as the issue is yet to be debated and RBI still has to take a call on whether to free it completely or regulate it beyond thresholds. If savings bank interest rate were to be deregulated, banks will see movement in CASA among themselves and customers are likely to benefit with higher rate of interest on deposits. Watch this space to track this development.

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