There is some good news for small investors. With the recent increase in interest rates, the rates on fixed deposits are bound to go up. This will be in tandem with the increase in interest rates on loans. In order to rein in the inflation rate, the Reserve Bank of India (RBI) raised its short-term lending (repo) rate by 50 basis points to 7.25 percent. The reverse repo rate, the rate at which banks park funds with the RBI, has been raised by 50 basis points to 6.25 percent.
At the same time, the RBI also increased the savings bank rate by 50 basis points to four percent to give higher returns to depositors in the wake of the high inflation. It is to be noted that unlike in the case of time deposits, the savings account interest rates are still regulated.
So, the interest rate on the money lying in a savings bank account will go up by half a percentage point. Deposit holders were receiving the rate fixed eight years ago. However, the move will raise the cost of borrowing for banks which leverage high on current and savings accounts (CASA) funds. The CASA deposits are much cheaper than the time deposits, where the going rate for six months and more is about eight percent.
The RBI put out a discussion paper debating the pros and cons of the proposal to deregulate savings bank deposit rates. It said in the discussion paper that the deregulation of this rate will allow banks to introduce product innovations which can benefit depositors.
Deregulation will essentially give banks the freedom to set interest rates on savings accounts, which is currently fixed at four percent. So, a depositor could get a higher interest rate on a savings account due to the move. The RBI has also pointed out that real interest rates - interest rates adjusted for inflation - have been largely negative for savings account holders. It said that account holders will benefit from deregulation as rates are likely to rise. It has also said that freeing interest rates will improve transmission of monetary policy by pushing up interest rates on savings accounts whenever the central bank raises policy rates.
The extent to which deregulation will benefit the small depositors is not yet clear. So far banks have been offering around the same returns on 7-15-day term deposits that they pay on savings accounts. Following the recent liquidity crunch, many banks have realised the importance of having a higher share of CASA deposits. They may be induced to raise interest rates to mobilise savings accounts.
At the same time, funds may not flow freely as there will always be some doubts about changes in the interest rate structure and penalties involved. According to some bankers, even in the current environment, investors have alternatives to savings accounts such as sweep-in accounts (where funds are transferred to fixed deposits on a daily basis). There are also liquid funds where investors can park funds for a couple of days.
