The State Bank of India (SBI) is the first bank to announce linking of its interest rates on deposits and loans to an external benchmark from May 1, 2019. The move implies that whenever the Reserve Bank of India (RBI) announces a change in the repo rate, it will automatically reset SBI's interest rates.Changes announced by SBI bank
In savings account with deposits balances above Rs 1 lakh, the effective interest rate will be 2.75% below repo rate, which is currently at 6.25%. With this, effective interest rate in savings account works out to be 3.5%, which is unchanged at present.
Further, all cash credit accounts and overdrafts above Rs 1 lakh would be priced at 2.25% over the repo rate. So, at current repo rate of 6.25%, this comes to floor rate of 8.5% for the bank. On this floor rate, the bank will charge a risk premium based on the risk profile of the borrower.
Interest rates remain unchanged for savings account holders and borrowers with cash credit and overdraft up to Rs 1 lakh.Why these changes were announced?
These announcements from SBI came after a meeting of RBI Governor Shaktikanta Das in February, 2019 with top lenders asking them to effectively pass on the benefit of repo rate cut to the customers. On February 6, 2019, RBI had reduced its repo rate by 25 basis points to 6.25%.
Also, in December 2018, the RBI had asked banks to link all floating rate retail loan products to external benchmarks starting April 2019. As per RBI released statement on developmental and regulatory policies, these external benchmarks are RBI policy repo rate, or Government of India 91-days or 182-days Treasury bill yield produced by the Financial Benchmarks India Private Ltd (FBIL) or any other benchmark market interest rate produced by the FBIL.
While the RBI guidance was to pass on the benefit of falling interest rates to borrowers by linking lending rate to an external benchmark, SBI has also linked its savings bank rates (over a limit of Rs 1 lakh) to the external benchmark.
Sukanya Kumar, Founder & Director of home loan advisory firm, RetailLending.com said, “With this surprise announcement by SBI on linking savings account rates to an external benchmark, it means now both assets and liabilities in the bank’s balance sheet will move in same direction when there is a cut or hike announced in repo rate by the central bank. Linking only lending rates to an external benchmark could have led to increase pressure on liability side with woes of managing non-performing assets.”
However, PK Gupta, Managing Director, SBI told Moneycontrol that, “If policy transmission has to happen as per RBI regulatory, then both sides of the balance sheets have to be linked to policy rates by the banks. So, best way to do policy transmission is to link savings bank rate to the policy rate. This gives us flexibility to do policy transmission on asset side as well.”
Impact to depositors and borrowers
Now, depositors in SBI account with balance above Rs 1 lakh will see slight movements in the interest rates they presently earn. At present effective interest rate in savings account is 3.5%. However, if there is a repo rate cut by 25 basis point in near term then interest rate on the savings account would also fall in similar way.
So, interest rate on savings account will be 3.25% and if there is a hike in repo rate by 25 basis points in future then interest rate on the savings account will be 3.75%. Above illustration is based on announcement by SBI of linking the interest rate in savings account (more than Rs 1 lakh). So, effective interest rate will be 2.75% below repo rate (current and future announcements).
Arvind Rao, a Mumbai-based financial advisor and founder of Arvind Rao and Associates explained, “In case there is a reduction in repo rate there won’t be any major impact on your savings account in absolute terms.”
For instance, you have Rs 5 lakh in your savings account and current interest rate is 3.5% per annum. You would have earned Rs 17,500 as interest on savings account at end of the year. If there is repo rate cut by 50 basis points by central bank then interest rate on your savings account will reduce to 3% based on changes announced by SBI (explained above). Now, you will earn Rs 15,000 as interest on savings account at end of the year. So, overall reduction is of Rs 2,500 which is small in absolute terms but seems bigger on percentage wise.
Although, there would be an impact on savings account; it would be minimal as explained above. Also, if other banks follow suit, the impact would be there as well to savings account holders.
However, with linking of interest on savings account to repo rate by SBI bank, Kumar believes this is a first step by an Indian bank to move towards near-zero interest on savings account like some of the banks in United States of America (USA).
According to bankrate.com the average interest rate on a savings account was a minuscule 0.10 percent in USA (as per calendar year 2018), meaning consumers are collecting virtually no interest on their savings account. This has happened in USA because banks have seen rise in deposits from consumers seeking a safe haven for their money amid volatility in the stock market.
In India, we could also see near-zero interest on savings account, if there is excess amount lying ideal in savings account / deposits and there is lack of demand for loans at these banks.
Harshvardhan Roongta, CFP is Principal Financial Planner at Roongta Securities said, “It’s a good decision by SBI of not linking fixed deposits rates to an external benchmark like public provident fund (PPF) and other small savings schemes which are linked to Gsec rates. Since, many conservative investors are investing in fixed deposits with banks and depending on interest income.”
However, in near term SBI don’t have plans to link fixed deposit rates to external benchmarking. Gupta said, “To do that bank needs to move fixed deposits rates on to the floating rates and we find that consumers don’t like floating rates on deposits. We tried in the past but it was not successful.”
For borrowers, this change means any cut or hike in repo rate will be directly reflected in base rates. However, frequency of change in loan rates will increase on quarterly basis since linked with repo rates. This could get a bit complicated for borrowers to track and understand but it also means that the interest rates would be more transparent.Will other banks follow SBI footsteps?
Other public sector banks will follow, they can’t ignore it but financial experts believe private banks will prefer waiting for some time before they follow suit. Gupta said, “We have given one way how the transmission can happen. It’s up to other banks whether they want to follow similar method or come up with other alternate that needs to be watch out.”
Rao added, “The stable private banks will analyze how the SBI announcement of linking with repo rate is going down with the account holders and borrowers then announce linking with external benchmark of RBI.”
At SBI, savings bank deposits are linked at 2.75% below current repo rate of 6.25% and loans at current repo rate 6.25% plus a spread of 2.25%. But, financial experts believe other public sector banks and private banks may announce some other spread for savings and lending on repo rate or come out with other method of linking with external benchmark sooner or later.