The Reserve Bank of India has signalled its intention to deregulate savings account rates. This is a significant move considering that savings and current account rates are the only two deposit rates currently regulated by the central bank and until the recent increase from 3.5% to 4%, savings account rates had remained unchanged since March 2003.
CURRENT SCENARIO: Savings accounts represent roughly 13% of household financial assets in India and, over the past 10 years, the yield on these deposits has been significantly below the inflation rate, thus resulting in a 'real' decline in household wealth insofar as these deposits are concerned. So, for example, with the current inflation at 9%, the 'real' savings rate is negative 5%, which means the customers real worth is getting eroded each year.
An administered interest regime might not make a material difference to customers who use such accounts for purely transactional purposes — most metropolitan households, for instance. But for rural and semi-urban households, which tend to use this as their primary savings instrument, it leads to an erosion of real worth over time.
THE FUTURE: We might be looking at two types of accounts offered post deregulation:
HIGH INTEREST SAVINGS ACCOUNTS: These will typically have restrictions on withdrawals, either through number of transactions, access to branches or transaction amounts. It is also likely that they will have a minimum balance requirement. These accounts may also offer tiered interest rates or interest rates linked to market rates, thus incentivising people who carry higher balances in their savings accounts.
A typical example of this type is the 'online only' accounts that are currently offered in countries like the US, UK and Australia. These accounts generally have the highest interest rates (approaching those of term deposits), generally do not offer cheque books, restrict access to branches and limit the number of free withdrawals the customer can make. It is expected that these accounts will compete with savings that are currently being channelled to term deposits and short-term liquid funds.
TRANSACTION ACCOUNTS: These accounts typically offer flexibility in the number of transactions – all the way to unlimited free withdrawals, cheque books, access to branches and phone banking. Due to the higher costs to the bank in offering these accounts, they offer lower interest rates than the high interest savings accounts.
THE CUSTOMER: There has been a great amount of discussion on the impact deregulation would have on customers – from the positive (rate competition) to the negative (increased complexity due to rapid product innovation). It is, therefore, extremely important for customers to understand what this means to them and what they may need to do. The customers who will benefit most from deregulation would be those that are proactive in understanding their usage of savings accounts, in managing their liquid savings and in choosing the deposits that best meet their needs.
While the current savings regime 'averages' the interest rate assuming everyone saves and transacts in an identical manner – therefore resulting in a 'saver' subsidising the 'transactor', deregulation will result in typically two types of accounts – one that offer rates higher than what are being currently offered and one with transaction facilities better than what are currently being offered.
The ideal situation for customers, therefore, would be to take advantage of both these aspects and to have two accounts — one for their liquid savings and one for their transactions. Recognising that sometimes customers feel that the complexity of maintaining two accounts is not worth the increased benefit, banks overseas also offer 'linked' accounts – one with a lower rate for transactions with a sweep facility attached to a higher rate savings account.
Also on offer are hybrid accounts that offer a mix of higher rates and transaction facilities. Choosing the wrong account can often result in the benefit of the higher rate being negated by the high transaction costs that are paid by the customer. It is important for customers to understand their transaction behaviour before deciding which account can offer the highest rate while charging minimal fees.
CAVEAT: In a rising rate environment, like the one we are currently in, it is evident that a deregulated savings interest rate will provide customers the opportunity to earn a higher rate of interest than they currently earn on their savings accounts. It is important for customers to also note that deregulation can also have the reverse effect. That is, when interest rates start going down, historical data suggests that savings account rates will follow it down much faster than if it were regulated.
Summing up, I think that it is a welcome move for customers and should result in interesting innovations on the product front in the Indian banking industry.
