State Bank of India's (SBI) move to link savings deposits of more than Rs 1 lakh with the repo rate is novel and merits attention. This is probably the first time that a deposit is being linked with a floating rate which here is the one determined by the Reserve Bank of India (RBI). How is one to view this move?
Savings account are supposed to be transient in nature as income gets transferred in periodically and is taken out to meet expenses by households. There is an interest rate of 3.5 percent paid by most banks while some private banks can offer up to 6 percent. These balances are normally sticky; and rarely would one move from one bank to another because of higher rates being offered or else all savings banks funds should have gone to the private banks.
This is an assumption made by SBI when linking the return on savings deposits of above Rs 1 lakh to 275 bps below the repo rate. Presently with the repo rate at 6.25 percent, all savings account holders would get 3.5 percent. But once the repo rate is lowered further to say 6 percent, the return would be just 3.25 percent, and the holders would be at a loss.
Let us look at the SBI view first. The RBI has been talking of better transmission from the repo rate to the lending rate. The main lending rates, i.e. Marginal Cost of funds based Lending rate (MCLR) and base rate are determined by a formula which includes the cost of borrowing from the RBI through the repo window as well as the cost of deposits. The 1 percent norm of Net Demand and Time Liabilities (NDTL) holds for the borrowings from the repo window and hence even 1 percent reduction in repo lowers cost of deposits by just Rs 1,500 crore for the system as a whole and hence does not affect these benchmarks. However, by now directly lowering the cost of deposits the MCLR should come down at a quicker pace.
SBI is starting off by levying this variable rate for only high denomination deposits of Rs 1 lakh and doing a similar thing on lending rates too on similar amounts. Cash credit accounts and overdrafts above Rs 1 lakh would be priced at 2.25 percent over the repo rate and hence the floor today is 8.5 percent over which there will be a risk premium charged based on the risk profile of the borrower. Therefore, theoretically, this is a sound proposition.
The customers would not be too happy with this move. First, all those who settle for bank deposits do so because they are risk averse and do not want to take market risk. By linking any deposit rate to the external benchmark, deposits become inferior. In fact, liquid mutual funds where money can be retrieved in a day's time are preferable as they give even better returns. Therefore, conceptually such a thing will not appeal to a deposit holder and anyone starting off fresh with a savings deposit which could be high would prefer to bank with an organization which gives a fixed return.
Second, those who have high balances of above Rs 1 lakh would now have to weigh their options. When balances are low at say Rs 10,000 one may be agnostic to interest rates as the return is not significant. But if it of high value, it makes sense to move over to another bank and earn 5-6 percent which is being offered. Therefore, inertia, which is what SBI, is assuming with such a move, has a cost which can be avoided by moving away.
Third, as there is a sweep in and sweep out facility offered on term deposits, it makes sense to convert all balances above Rs 1 lakh into term deposits and use the sweep facility to maximise returns. Hence from the point of view of the bank, it may end up paying more interest than it would have done at a fixed rate of 3.5 percent.
Fourth, for those still loyal to the bank, opening additional accounts in branches is an option to spread the balance so that the status quo does not change. For sure deposit holders will not be too pleased with this move and the important thing will be the interest rate differential. In case the RBI lowers the rate by say 50 bps in 2019, then the savings rate would come down to 3.
On the whole, hence, the idea of having a flexible interest rate on savings accounts is definitely not a good one from the point of view of a customer. Those having higher balances would be financially savvier and may not like to keep an account which gives an inferior return. They are more likely to migrate to other avenues as stated earlier.
SBI is evidently experimenting with a plan which can make commercial sense and be acceptable to the regulator too as it fosters better transmission. If successful, the same can be extended to lower denominations too. Therefore, two things need to be tracked. First is how individuals with over Rs 1 lakh in a savings account respond to relatively lower interest rates on their balances. Second, whether the cost of funds for SBI comes down significantly to be transmitted to the lending side even though the same has been done for cash credit and overdraft.
Will other banks do the same? The answer is probably yes when it comes to the public sector as they do tend to do what the leader initiates. Also given that they are owned by the Government of India, there would be a reason to believe that all PSBs will follow suit as it delivers what it is supposed to do i.e. better transmission.
It is certainly interesting that the SBI has used the route of better transmission by going to the source of funding and linking the same with an external benchmark. Volatility in the repo rate is less than a market rate like say the GSec or Tbill. Small savings have been linked with the GSec movements on a periodic basis and hence using the repo is the starting point for benchmarking bank deposits. If this is accepted by customers, the same can be done for term deposits too so that the process is automatic. While this may be acceptable to customers in an upward moving cycle, it would be negative when rates move down. Banks already have faced the challenge of slower growth with the migration of savings to mutual funds which can get exacerbated in case it is extended to term deposits.
(The writer is chief economist, CARE ratings)