RBI draft favours freeing of savings banks interest rate

MUMBAI: The Reserve Bank today said that deregulation of the interest rate on savings banks accounts would benefit savers, as it would enable lenders to come out with innovative products to attract more funds from low income households.

"Deregulation will also allow banks to introduce product innovations which could also benefit the depositors," the RBI said in its draft discussion paper while inviting public comments on freeing the interest rate on savings account.

While the RBI deregulated interest rates on fixed deposit schemes in 1997, it continues to fix the rate on savings deposits. Presently, banks pay interest at the rate of 3.5 per cent on saving accounts, which was fixed in 2003.

Giving the pros and cons of deregulation of savings account interest rates, the RBI paper also said the apprehensions that such a move would lead to "unhealthy" competition among the banks are unfounded.

Pointing out that the deregulation of fixed deposit rates 13 years did not result in unhealthy competition among the banks, "deregulation of savings deposit rate may also not result in any unhealthy competition," it said.

Moreover, the paper added that savings deposit interest rates cannot be regulated for all times to come when all other interest rates have already been deregulated, as it creates distortions in the system.

International experience suggests that in most countries, interest rates on savings bank accounts are set by the commercial banks based on market interest rates, it said.

Citing the fact that most countries in Asia experimented with interest rate deregulation, the paper said these resulted in positive real interest rates, which in turn contributed to an increase in financial savings.

Deregulation of the interest rate on savings deposit will make the rate flexible along with other interest rates, depending on the market conditions.

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

The paper also noted that the flexibility will have another major advantage in that it will help improve monetary transmission. Since savings deposits constitute a significant portion of aggregate deposits, regulation of interest rates on such deposits has impeded the transmission of monetary policy impulses.

On the negative side, the deregulation could lead to an asset-liability mismatch and could adversely affect small savers and pensioners.

The last date for sending suggestions and comments on this issue is May 20.