Deregulation

SOP GROUP:11GROUP MEMBERS:AKHIL PFINNY TOMLAKSHMI PRIYAREYAN JOHNYSONY ROY

DEREGULATION OF SAVINGS BANK ACCOUNT INTEREST

RATE

A deposit account held at a bank or other

financial institution that provides principal

security and a modest interest rate.

Most liquid investments outside of demand

accounts and cash.

Combination of current account and term

deposits.

Savings bank account

Number of free withdrawals are generally

stipulated on a half-yearly/quarterly basis.

No ceiling has been stipulated on the

maximum amount drawn per transaction.

There is generally no limit on the number of

cheques that can be drawn per month.

FEATURES

Interest on savings accounts is usually

compounded daily and paid monthly.

Daily compounding = Principal (1 + interest

rate/365)365 = (daily compounded amount)

The most common type of bank account.

Minimum balance is stipulated.

Banks usually offer two types of savings

accounts:

a) Basic savings account or passbook savings

account.

b) Money market account.

TYPES OF SAVINGS ACCOUNT

A Historical Account of Deregulation of Deposit Interest Rates in India

Early 1990’s – India pursued financial sector reforms as a part of structural reforms.

Major components of financial sector reform process are,

• Deregulation of complex structure of deposit• Lending interest rates

April 1985 – Banks allowed to set interest rates for maturities between 15 days upto 1 year.

May 1985 – Withdrawn the freedom. April 1992 – Single ceiling rate of 13% for all

deposits above 46 days. November 1994 – Ceiling rate was brought

down to 10%. April 1995 – Raised to 12%. October 1995 – Banks were allowed to fix

interest rates on deposits with maturity of over 2 years.

July 1996 – Relaxed to maturity of over 1 year.

April 1997 – Ceiling rate for deposits of 30 days upto 1 year was linked to Bank rate.

October 1997 – Deposits rate were fully deregulated by removing the linkage to Bank rate.

April 1998 – RBI gave freedom to commercial banks to fix their own interest.

Trend in Savings Bank Deposits in India

An interest rate is the cost of borrowing money

The interest a lender receives is his compensation for taking a risk

interest rate is your compensation for temporarily giving up the ability to spend your cash.

Interest rate for secured credit and unsecured credit

INTEREST RATE

INFLATION:-

NO INFLATION OR DEFLATION IS A WORSE

ECONOMIC INDICATOR.

LOWER INTEREST RATES PUT MORE

BORROWING POWER IN THE HANDS OF

CONSUMERS.

INFLATION AND INTEREST RATE

The process of deregulation started in October 1997.

Deregulation – prior to this the interest rate was 3% to 4% .

It was fixed and regulated by RBI . As a result of deregulation the interest rates

are higher for deposits of more than Rs 1 lakh.

Interest rate for the amount upto 1 lakh,banks are supposed to maintain same interest rate.

DEREGULATION OF SAVINGS ACCOUNT INTEREST RATE

Interest rates on savings account in developed countries determined by the commercial banks according to market conditions.

Savings bank accounts may carry customer charges.

Many Asian countries deregulated interest rates to support

- overall development and growth policies.

INTERNATIONAL EXPERIENCE

May Enhance Attractiveness of Savings Deposits

a. There was no changes in the interest rate in response to changing market condition

b. Since savings bank deposits in rural, semi-urban areas and urban areas are held largely for savings purposes, deregulation of interest rate is likely to enhance its attractiveness in these areas.

Pros

Will Improve Transmission of Monetary Policy

a. transmission of monetary policy to be effective, it is necessary that all rates move in tandem with the policy rates

b. overall cost of deposits does not move in sync with changes in the policy rates, thereby affecting the monetary transmission

Product innovations may include a variety of modes of operations such as branches, web-based channels, ATMs etc

combined savings and checking accounts launched in Hong Kong

May Lead to Product Innovations

Possibility of an Unhealthy Competition Risk of Asset Liability Mismatches May Lead to Financial Exclusion Could Adversely Affect Small

Savers/Pensioners Possibility of Introduction of Complex and

not so Easily Understood Savings Products

Cons

a. low cost source of fundb. 49 banks, which have below average CASA

deposits, constitute about 50 per cent of total asset of the banking sector.

Possibility of an Unhealthy Competition

a. a large part of savings deposits is treated as ‘core’ deposits, which together with term deposits have been used by banks

b. as an asset-liability mismatch wherein assets (loans) have a longer maturity compared to liabilities (deposits).

c. shift funds from one bank to another in search of returns.

Risk of Asset Liability Mismatches

High transaction cost This will discourage small savers, especially

in rural and semi- urban areas from opening savings deposits accounts.

May Lead to Financial Exclusion

when the liquidity is in surplus, when savings deposit interest rates may decline even below the present level.

Could Adversely Affect Small Savers/Pensioners

DEREGULATION IMPACT ON BANKS

Increased costs and decreased profitability Less takers for short term fixed deposits Increased competition Asset and liability of banks

IMPACT OF DEREGULATION

Higher earnings from saving accounts Short term investment option Increased cost of loans for borrowers Increased charges

DEREGULATION IMPACT ON DEPOSITORS

LIQUID FUNDS ARE MUTUAL FUNDS SOME INVESTORS MIGHT MOVE THEIR

FUNDS TOWARDS SAVINGS ACCOUNT AS IT OFFERS HIGHER LIQUIDITY AND SAFETY OF THE PRINCIPAL AMOUNT.

liquid funds yield better returns if we take tax rate into account.

With deregulation, this category of mutual fund will definitely offer more innovation.

IMPACT ON LIQUID FUNDS

Savings deposit interest rate can not be regulated for all times to come when all other interest rates have already been deregulated as it creates distortions in the system.

The RBI said that deregulation of interest rates in India since the early 1990s has improved the competitive environment in the financial system, imparted greater efficiency in resource allocation and strengthened the transmission mechanism of monetary policy.

CONCLUSION

Deregulation of interest rates on savings bank account will only prompt customers to move from one bank to another, rather than bringing in new customers into the banking system.

Banks wishing to enjoy cheaper (savings bank) funds will, therefore, have to work much harder on non-interest factors like service quality, ease of access and other related services on offer to retain customers and ensure their loyalty