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Friday, April 29, 2011

Inflation control: RBI builds case for freeing savings bank rate

MUMBAI: The Reserve Bank of India, criticised for failing to contain inflation , is building a case to do away with the last of the regulated interest rates - savings bank rate - for an effective policy transmission. But the freedom for banks to set rates could hurt the poor, for whom savings account is the lone investment product, and limit access to financial services.

The central bank may proceed gradually in letting it free by keeping a floor on the rates offered in the early stages. The freeing-up could also lead to higher rates for savers, if banks compete for funds. "Savings deposit interest rate cannot be regulated for all times to come when all other interest rates have already been deregulated as it creates distortions in the system," says a discussion paper on Deregulation of Savings Bank Deposit Interest Rate by RBI, seeking comments till May 20.

Other than innovative products, "deregulation will have another major advantage, in that it will help improve the monetary transmission . Since savings deposits constitute a significant portion of aggregate deposits, regulation of interest rate on such deposits has impeded the transmission of monetary policy impulses," notes the paper.

Savings Bank accounts is a basic banking service for an individual who opens a bank account to transact , but can also use it as a saving instrument. Although all deposit rates were de-regulated by 1997, this alone was kept to protect the neediest, who did not have any other avenue to invest.

The rate on this type of a hybrid account was last set in 2003 at 3.5% a year. Since these deposits account for about a quarter of all deposits , these fixed rates left policy rate increases by the central bank ineffective. Eight rate increases in 13 months failed to contain price rise that is at least a percentage point above the targeted 8%.

The household sector has 84% of the total savings deposits of about Rs 9 lakh crore, of which 36.2% are from the rural and semiurban population which mostly don't trade in shares, bonds and other securities. Savings bank deposits account for 12.8% of the total household financial assets. "The de-regulation has to happen in a phased manner," said Madan Sabnavis, chief economist at raging company CARE.

"When we are talking about inclusive banking, we have to see that the interests of small depositors are protected. No one is going to switch bank accounts frequently mainly due to changes in savings rates," he said. But the central bank believes that deregulation may lead to higher returns for depositors. Furthermore , banks won't compete with each other for funds and destabilise the system.

"If deregulation of term deposits did not lead to any unhealthy competition , deregulation of savings deposit rate may also not result in any unhealthy competition," said the RBI paper.

"While attractive returns may encourage low income households to open such accounts , it may also reduce accessibility of such accounts for small savers if banks impose some restrictions on the operation of such accounts. However, such issues are better addressed by regulatory prescriptions rather than by regulation of interest rates," it said.

Source: EconomicTimes


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