RBI draft for freeing banks interest rate

The Reserve Bank of India said on Thursday that deregulation of the interest rate on savings banks accounts would benefit savers, as it would enable lenders to come out with innovative products to attract more funds from low income households.

"Deregulation will also allow banks to introduce product innovations which could also benefit the depositors," the RBI said in its draft discussion paper while inviting public comments on freeing the interest rate on savings account.

While the RBI deregulated interest rates on fixed deposit schemes in 1997, it continues to fix the rate on savings deposits.

Presently, banks pay interest at the rate of 3.5 per cent on saving accounts, which was fixed in 2003.

Giving the pros and cons of deregulation of savings account interest rates, the RBI paper also said the apprehensions that such a move would lead to 'unhealthy' competition among the banks are unfounded.

Pointing out that the deregulation of fixed deposit rates 13 years did not result in unhealthy competition among the banks, 'deregulation of savings deposit rate may also not result in any unhealthy competition,' it said.

Moreover, the paper added that savings deposit interest rates cannot be regulated for all times to come when all other interest rates have already been deregulated, as it creates distortions in the system.

International experience suggests that in most countries, interest rates on savings bank accounts are set by the commercial banks based on market interest rates, it said.

Citing the fact that most countries in Asia experimented with interest rate deregulation, the paper said these resulted in positive real interest rates, which in turn contributed to an increase in financial savings.

Deregulation of the interest rate on savings deposit will make the rate flexible along with other interest rates, depending on the market conditions.

Since savings bank deposits in rural, semi-urban and urban areas are held largely for savings purposes, deregulation of interest rates is likely to enhance its attractiveness in these areas, it said.

The paper also noted that the flexibility will have another major advantage in

that it will help improve monetary transmission.

Since savings deposits constitute a significant portion of aggregate deposits, regulation of interest rates on such deposits has impeded the transmission of monetary policy impulses.

On the negative side, the deregulation could lead to an asset-liability mismatch and could adversely affect small savers and pensioners.

The last date for sending suggestions and comments on this issue is May 20.

Although deregulation of savings deposit interest rates may lead to product innovation, which, in general, will benefit savers, it is also possible that the banks will introduce some complex products, which may not be so easily understood by savers, the discussion paper said.

These strategies may result in increase in the mis-selling of savings bank products, which will also result in an increase in the number of customer complaints, it said.

There is also an apprehension that deregulation could lead to financial inclusion.

Banks might be discouraged from maintaining savings deposits with small amounts due to the associated high transaction costs, it said, adding this could particularly be the case with public sector banks, which have a large number of savings accounts and which allow depositors to maintain very low balances.

Thus, it is likely that banks either increase the minimum balance to be maintained or reduce the number of transactions permitted free of cost and increase the customer service charges too, it said.

Saving bank accounts had deposits to the tune of Rs 8,96,301 crore (Rs 8,963.01 billion) at the end of March, 2009, against Rs 4,40,339 crore (Rs 4,403.39 billion) at the end of March, 2005.

The rural and semi-urban population contributed 36 per cent to the total savings deposits amount, while the urban share was 26 per cent at the end of March, 2009.

The remaining amount came from the metropolitan population.