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Saturday, April 30, 2011

RBI kicks off savings bank rate debate

The interest rate on savings bank deposits, the last bastion of the administered rate of interest, is set to be deregulated, with the Reserve Bank of India (RBI) kicking off a discussion for a market-driven rate. The rate has remained at 3.5 per cent since March 2003.

While a strong argument favouring such a move is better transmission of the monetary policy, concerns like those regarding unhealthy competition among banks and asset liability mismatches remain. RBI seems to suggest the advantages of the move outnumber the concerns.

In a discussion paper released on Thursday, RBI charted the pros and cons of such a step. The regulator is considering deregulating the savings bank rate in a phased manner, subject to a minimum floor for some time. It ignited a debate on whether higher interest rate be paid on savings deposits without a cheque-book facility. However, it was also argued that for transmission of monetary policy to be effective, it was necessary that all rates move in line with policy rates and that the process was impeded if the interest rate in any segment was regulated.

Regulation of savings bank deposits, which constitutes 22 per cent of all deposits, has not only reduced its relative attractiveness, but also adversely affected transmission of monetary policy, RBI said.

An important drawback of a market-determined savings bank rate is that competition would increase the cost for banks and affect profitability. “It has also been observed that 49 banks, which have below average CASA deposits, constitute about 50 per cent of total assets of the banking sector. Therefore, given the attractiveness of savings deposits, it could be argued that deregulation may lead to unhealthy competition amongst banks,” RBI said.

So far, banks have, opposed deregulation of savings bank deposits, saying such a move would fuel instability. Another drawback in moving to a market-driven savings bank rate is that it would result in an asset-liability mismatch. Though savings bank deposits represent short-term savings which can be withdrawn on demand, a large part is treated as ‘core’ deposits, which, together with term deposits, were used by banks to raise their exposure to long-term loans, including infrastructure loans.

It is also argued that such a move would adversely impact financial inclusion, as banks may be discouraged from maintaining savings deposits with small amounts, due to the high transaction costs involved.

Source: Business Standard


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