Borrowers typically rejoice when the Reserve Bank of India (RBI) lowers the key policy rate and commercial banks subsequently promise lending rate cuts. This is because of the hope that their interest rate on loans will fall soon. But the euphoria doesn't last long. Often, the gains from a marginal cut in lending rates won’t make a significant difference to your monthly equated monthly instalment (EMI). Banks typically pass on only a fraction of the RBI rate cuts to protect their margins. And the real shocker comes next.
Banks typically lower their deposit rates too along with the lending rate cuts. The quantum of cut here will be bigger and banks typically slash deposit rates, in a falling interest rate scenario, multiple times in a short interval. The gains for a borrower will be typically far lower than the loss of a saver. This scenario is happening now.
A few large banks have cut the interest rates on savings deposits in recent days. In a slowing economic environment, where every other asset class appears high risk, bank deposits are seen as the safest avenue for common people, particularly senior citizens. But with banks slashing deposit rates, this option too has become unattractive for savers.
On Tuesday, both State Bank of India (SBI) and ICICI Bank cut their savings deposit rates. SBI will now offer 2.7 percent on savings deposits from May 31 while ICICI Bank will offer 3 percent for deposits up to Rs 50 lakh and 3.5 percent for deposits above Rs 50 lakh. Similarly, Axis Bank cut its savings rate to 3.5 percent early this month. Also, last month, Kotak too cut its savings rate to the same level. This trend was evident after SBI kicked off the trend two months ago. On 8 April, SBI slashed its savings bank deposit rate to 2.75 percent.
SBI had a good reason for lowering the savings rate. Ever since bank savings rate deregulation happened in 2011, savings rate among large Indian banks has remained unchanged at 4 percent. Till then the rate was administered at 3.5 percent for several years (the change before that was done in 2003). Though lending rate deregulation happened in India in the 1990s, savings rate continued to be an administered rate.
When this rate was deregulated, the idea was to give an opportunity to the common savers to earn high returns as it was believed that competition would prompt banks to offer better savings rate. Both fixed deposit rates and lending rates have been tweaked several times but not savings rates. Certain smaller and medium-sized banks have offered higher rates, but the industry has largely agreed upon a 4 percent rate. With savings deposit rate falling to average 2.7-3 percent, depositors do not have any incentive to keep money in savings accounts.
Even fixed deposit rates have been falling. Last month, ICICI Bank cut fixed deposit rates by up to 50 basis points effective May 11. Deposits up to one year will now yield 5.25 percent while those above one year will earn 5.7-5.75 percent, according to the interest rate card on the bank's website. Earlier, the bank used to offer 25-50 bps more on these maturities. Similarly, SBI and many other banks too have been cutting rates on fixed deposits in multiple tranches.
Why are banks slashing deposit rates? There is no real surprise here. With no demand for credit in a locked-down economy, banks are flush with liquidity and do not want further inflow of deposits. In other words, banks want to disincentivise the inflow of deposits by making the returns less attractive. Also, the RBI has cut repo rate by 115 basis points (bps) prompting banks to bring down lending rates as well. One bps is one-hundredth of a percentage point. When banks are pushed to cut the lending rates, they reduce the deposit rates as well.
What about rates on other instruments other than bank FDs? The return on these instruments has also been aligned with industry rates. Last month, the RBI said it will stop issuing the Government of India’s 7.75 percent (taxable) bonds without explaining why it decided so. There was good demand for these instruments since these bonds carried no risk with a seven-year maturity.
The interest rate on other small savings too has been brought down recently. In April, the PPF rate was cut from 7.9 percent to 7.1 percent and the interest rate on Sukanya Samridhhi Yojana was brought down to 7.6 percent from 8.4 percent earlier. Having said that, the returns on small savings are still attractive compared with bank fixed deposits. A one-year FD now gives around 5.25 percent and longer maturities less than 6 percent in most banks.
When economic growth is projected to contract this fiscal and overall interest rates headed downwards, it is not surprising that deposit rates/ return on other savings instruments are sliding fast. Had there been other avenues for an average investor, this wouldn’t have been a big problem. That’s not the case now. Equity markets are too risky, mutual funds are fighting a trust deficit post the infamous Franklin Templeton episode, real estate and gold-- two other traditional safer assets--aren’t attractive from a return perspective. In short, there aren’t many options. These are bad times for an average saver. It is important that the government offers an attractive alternative for savers.
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