Confused by savings interest rate? Read on...

RBI's deregulation drive on saving interest rates has created a competitive environment across banks in an effort to retain and capture a loyal customer base.

The second quarter of the monetary policy review instructed banks to implement deregulation of savings bank rates with immediate effect, allowing banks to set their own interest rates. The rate of interest in savings bank account was four per annum as mandated by the government in May 2011.

However with the recent change banks are now allowed to fix their interest rates for saving account customers. Banks now use this as a competing factor and weave it into their merits to enhance their customer base.

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The happy news for savings account holders is maximum benefits for their money irrespective of the time period. Before deregulation there was hardly any competition in this segment, and all banks offered the same rate of interest.

So, there were no second thoughts for customers about shifting their savings account from one bank to another. However, now customers think twice before they start a new account or wish to switch an existing account to get the maximum benefits.

Many wonder how banks calculate their savings account interest. Let us understand this process with an example: Earlier banks used to pay an interest rate of four per cent per annum against the lowest available balance in the account between the 10th and final day of a month.

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Any deposits happening during this period were not eligible for interest rate calculation of that month, but at the same time, withdrawals during the period were taken into account.

For instance, Vishal had a balance of Rs 50,000 in his account as on January 10. On January 20, he received Rs 100,000 as maturity bonus for his LIC policy. On January 28, he had withdrawn Rs 125,000 for making a down payment for his new flat, thereby reducing his account balance to Rs 25,000.

In his case, the bank would consider Rs 25,000 for interest calculation, as it is the lowest amount available in his account between 10 and 28 January.

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So, the interest amount Vishal is eligible for the month of February will be for Rs 25,000 at four per cent per annum, which amounts to Rs 83.33. Effective from April 1, 2010, onwards, following RBI's mandate to rework interest rate calculation methods, banks started calculating interest on a 'daily balance method'.

Let's see what difference this move can make to Vishal's interest earned on his savings account: From January 1 to 20, he will be paid an interest for Rs 50,000. From 20 to 28, interest is calculated for Rs. 150,000 and for the remaining three days, interest is calculated on Rs 25,000.

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So, the interest he earns for January will be Rs 249.28/- against the older method, whereby he would have earned Rs 83.33 only. So, now every rupee you keep in your account earns for you and you need not plan ahead for your withdrawals to gain maximum benefits.

Now, let us understand how the de-regulation works for you when clubbed along with the new interest rate calculation method.

Benefits of Deregulation

i) It raises the level of competition between banks which directly benefits the customers.

ii) Maximum return for your money.

iii) High interest rates on short term deposits (less than six months).

iv) Switching banks offers better options.

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Provided below is a comparison of the interest rates offered by different banks on saving accounts:

Bank name, savings interest rate below Rs 1 lakh, savings interest rate above Rs 1 lakh.

Axis Bank, four per cent per annum, four per cent per annum.

Citibank, four per cent per annum, four per cent per annum.

HDFC Bank, four per cent per annum, four per cent per annum.

HSBC Bank, four per cent per annum, four per cent per annum.

ICICI Bank, four per cent per annum, four per cent per annum.

IDBI Bank, four per cent per annum, four per cent per annum.

Indus Ind Bank, 5.5 per cent per annum, six per cent per annum.

Kotak Bank, 5.5 per cent per annum, six per cent per annum.

State Bank of India, four per cent per annum, four per cent per annum.

Yes Bank, six per cent per annum, seven per cent per annum.

The data in the above table does dampen the initial excitement that the deregulation drive created.

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However, it could still be early days and with various RBI measures on other fronts it could just be a matter of time before this aspect becomes a reason for people to have more liquid cash in their accounts, the daily balance calculation is already a valid reason enough.

However one must also remember that if banks compete to raise interest rate on the savings account, it may result in lending rates going up to maintain balance and the profit equation.

However, other market conditions also come into play here and one reason alone cannot be isolated as being responsible for any kind of change.