Skip to main content

Savings Rate Deregulation and its effects



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.

 

Popular posts from this blog

Tata Mutual Fund

Being a part of the Tata group, the fund has the backing of a very trusted brand name with strong retail connect. While the current CEO has done an excellent job in leveraging the Tata brand name to AMC's advantage, it is ironic that this was just not capitalised on at the start. Incorporated in 1995, Tata Mutual Fund remained an 'also-ran' fund house for around eight years. Till March 2003, it had a little over Rs 1,000 crore in assets and 19 AMCs were ahead of it. But soon after that the equation changed. It was the fastest growing fund house in 2004 and 2005. During these two years, it aggressively launched six equity funds, two debt funds and one MIP. The fund house as of now stands at No. 8 in terms of asset size. This fund house has a lot to offer by way of choice. And, it also has a number of well performing schemes. Tata Pure Equity, Tata Equity PE and Tata Infrastructure are all good funds. It also has quite a few good debt funds. The funds of Tata AMC are known to...

UTI Mutual Fund

Even though only a few of UTI’s funds are great performers, this public sector fund house has many advantages that its rivals do not. It has a huge base of retail equity investors and a vast distribution network. As a business, it looks stronger than ever, especially in the aftermath of credit crunch. UTI is, by a large margin, the most profitable fund company in the country. This is not surprising, since managing equity funds is more profitable than debt. Its conservative approach and stable parentage is likely to make it look more attractive to investors in times to come. UTI’s big problem is the dragging performance that many of its equity funds suffer from. In recent times, the management has made a concerted effort to improve performance. However, these moves have coincided with a disastrous phase in the stock markets and that has made it impossible to judge whether the overhaul will eventually be a success. UTI’s top performers are a few index funds, some hybrid funds and its inf...

Salary planning Article

1. The salary (basic + DA) should be low. The rest should come by way of such allowances on which the employer pays FBT and you don't pay any tax thereon. 2. Interest paid on housing loan is deductible u/s 24 up to Rs 1.5 lakh (Rs 150,000) on self-occupied property and without any limit on a commercial or rented house. 3. The repayment of housing loan from specified sources is also deductible irrespective of whether the house is self-occupied or given on rent within the overall ceiling of Rs 1 lakh of Sec. 80C. 4. Where the accommodation provided to the employee is taken on lease by the employer, the perk value is the actual amount of lease rental or 20 per cent of the salary, whichever is lower. Understandably, if the house belongs to a family member who is at a low or nil tax zone the family benefits. Yes, the maximum benefit accrues when the rent is over 20 per cent of the salary. 5. A chauffeur driven motor car provided by the employer has no perk value. True, the company would...

8 Investing Strategy

The stock market ‘meltdown’ witnessed since the start of 2005 (notwithstanding the recent marginal recovery) has once again brought to the forefront an inherent weakness existent in our markets. This is the fact that FIIs, indisputably and almost entirely, dominate the Indian stock market sentiments and consequently the market movements. In this article, we make an attempt to list down a few points that would aid an investor in mitigating the risks and curtailing the losses during times of volatility as large investors (read FIIs) enter and exit stocks. Read on Manage greed/fear: This is an important point, which every investor must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles. By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-...

Debt Funds - Check The Expiry Date

This time we give you an insight into something that most debt fund investors would be unaware of, the Average Portfolio Maturity. As we all know, debt funds invest in bonds and securities. These instruments mature over a certain period of time, which is called maturity. The maturity is the length of time till the principal amount is returned to the security-holder or bond-holder. A debt fund invests in a number of such instruments and each of these instruments would be having different maturity times. Hence, the fund calculates a weighted average maturity, which would give a fair idea of the fund's maturity period. For example, if a fund owns three bonds of 2-year (Rs 30,000), 3-year (Rs 10,000) and 5-year (Rs 20,000) maturities, its weighted average maturity would be 3.17 years. What is the big deal about average maturity then, you may ask. Well, knowing a fund's average maturity is important because it tells you how sensitive a fund is to the change in interest rates. It is ...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now