Why are banks choosing to cut savings account interest rates?

Key Highlights: 

• Axis Bank offers 3.50% per annum interest up to Rs 50 lakh balance
• SBI offers 3.50% per annum  interest up to Rs 1 crore
• Cut in savings account will cushion NIM

Interest rates on bank deposits saw reduction for the first time in six years after State Bank of India (SBI) on July 31, 2017, announced a two tier interest rate.

A person with savings account balance of Rs 1 crore will continue to earn interest rates at 4% per annum while a person holding balance below Rs 1 crore will only earn interest rate of 3.5% per annum.

SBI group has saving deposits of Rs 9.4 lakh crore – 90% is below Rs 1 crore accounts which would now be getting interest rate of 3.5% per annum.

Many analysts believe other banks will follow the suit. Veekesh Gandhi and Ashish Kumar research analysts at Bank of America Merrill Lynch said, “We believe that other banks may follow suit as the liquidity in the system continues to remain high amidst a tepid loan growth environment.”

Axis Bank has already announced that savings account balance up to Rs 50 lakh will get interest rate of 3.50% per annum - a cut of 50 basis points from previous rate.

Who decides savings deposit rates?

The Reserve Bank of India on October 25, 2011, deregulated the savings bank deposit interest rate. Since then banks have been deciding the interest rates they offer. 

Banks since then are free to determine their savings bank deposit interest rate for resident Indians only with immediate effect subject to two conditions.

Firstly, each bank will have to offer a uniform interest rate on savings bank deposits up to Rs 1 lakh – irrespective of the amount in the account within this limit. Secondly, for balance above Rs 1 lakh – banks are allowed to provide differential rates of interest, if it so chooses, subject to the condition that banks will not discriminate in the matter of interest paid on such deposits, between one deposit and another of similar amount, accepted on the same date, at any of its offices.

Since then, banks have mostly increased the rates on savings account, while none reduced it. The interest rate has been 4% of most banks.

So why the reduction now?

Bringing savings account interest down was an outcome of large inflows in savings and current accounts during the demonetisation period between November – December 2016, as per SBI.

Surplus liquidity in the banking system was at peak of Rs 7.95 lakh crore as on January 4, 2017, reached to an average of Rs 6 lakh crore in February and later till Rs 4.80 lakh crore in March.

RBI in August monetary policy said, “Surplus liquidity conditions persisted in the system, exacerbated by front-loading of budgetary spending by the Government.”

But one of the major reasons of banks was the marginal cost of fund based lending rate (MCLR).

Bank of America Merrill said, “If a good part of deposits accrued on account of demonetization moves out over the following 3-6 months, banks will tend to either raise lending rates or alternatively cut deposit rates further. This is because we expected banks to focus on profitability in contrast to volumes. ”

Basically banks make money by lending money at rates that are higher than the cost of the money they lend. They collect interest on loans and interest payments from the debt securities they own and pay interest on deposits.

During January – March 2017 period, the base rate of banks came down from a range of 9.3 – 9.7% to 9.1% - 9.6% while the MCLR reduced from 8.95% to 7.75 – 8.20%.

After SBI, Axis Bank cuts interest rate on savings account