Understanding the savings interest rate scenario today

RBI’s deregulation drive on saving interest rates has created a competitive environment across banks in an effort to retain and capture a loyal customer base. The second quarter of the monetary policy review instructed banks to implement deregulation of savings bank rates with immediate effect, allowing banks to set their own interest rates.

The rate of interest in savings bank account was 4% per annum as mandated by the government in May 2011. However with the recent change banks are now allowed to fix their interest rates for saving account customers.

Banks now use this as a competing factor and weave it into their merits to enhance their customer base.

The happy news for savings account holders is maximum benefits for their money irrespective of the time period. Before deregulation there was hardly any competition in this segment, and all banks offered the same rate of interest. So, there were no second thoughts for customers about shifting their savings account from one bank to another. However, now customers think twice before they start a new account or wish to switch an existing account to get the maximum benefits.

So, how it is calculated?

Many wonder how banks calculate their savings account interest. Let us understand this process with an example:

Earlier banks used to pay an interest rate of 4% p.a. against the lowest available balance in the account between the 10th and final day of a month. Any deposits happening during this period were not eligible for interest rate calculation of that month, but at the same time, withdrawals during the period were taken into account.

For instance, Vishal had a balance of Rs.50000 in his account as on January 10th. On January 20th, he received Rs.100000 as maturity bonus for his LIC policy. On 28th January he had withdrawn Rs. 125000 for making a down payment for his new flat, thereby reducing his account balance to Rs. 25000. In his case, the bank would consider Rs.25000 for interest calculation, as it is the lowest amount available in his account between 10th and 28th January. So, the interest amount Vishal is eligible for the month of February will be for Rs.25000 @ 4% p.a. which amounts to Rs.83.33.

Effective from April 1, 2010 onwards, following RBI’s mandate to rework interest rate calculation methods, banks started calculating interest on a ‘daily balance method.

Let’s see what difference this move can make to Vishal’s interest earned on his savings account:

From January 1st to 20th, he will be paid an interest for Rs.50000.

From 20th to 28th, interest is calculated for Rs. 150000 and for the remaining three days, interest is calculated on Rs.25000/-

So, the interest he earns for January will be Rs.249.28/- against the older method, whereby he would have earned Rs. 83.33 only.

So, now every rupee you keep in your account earns for you and you need not plan ahead for your withdrawals to gain maximum benefits.

Now, let us understand how the de-regulation works for you when clubbed along with the new interest rate calculation method.

Benefits of Deregulation

•             It raises the level of competition between banks which directly benefits the customers

•             Maximum return for your money

•             High interest rates on short term deposits (less than 6 months).

•             Switching banks offers better options

Provided below is a comparison of the interest rates offered by different banks on saving accounts:

Bank Name		Savings Interest Rate below  Rs. 1 Lakh	Savings  Interest Rate above Rs. 1 Lakh
Axis Bank		4% p.a.	4% p.a.
Citibank		4% p.a.	4% p.a.
HDFC Bank		4% p.a.	4% p.a.
HSBC Bank		4% p.a.	4% p.a.
ICICI Bank		4% p.a.	4% p.a.
IDBI Bank		4% p.a.	4% p.a.
Indus Ind Bank		5.5% p.a.	6% p.a.
Kotak Bank		5.5% p.a.	6% p.a.
State Bank of India		4% p.a.	4% p.a.
Yes Bank		6% p.a.	7% p.a.

The data in the above table does dampen the initial excitement that the deregulation drive created. However, it could still beearly days and with various RBI measures on other fronts it could just be a matter of time before this aspect becomes a reason for people to have more liquid cash in their accounts, the daily balance calculation is already a valid reason enough! However one must also remember that if banks compete to raise interest rate on the savings account, in may result in lending rates going up to maintain  balance and the profit equation. However, other market conditions also come into play here and one reason alone cannot be isolated as being responsible for any kind of change.