Why fret over small savings rates? Business Line 25th March 2016

It is hard to believe that these schemes — just 7 per cent of bank deposits — restrain banks from lowering rates

The decision to lower the interest rates on small savings is curious not so much because it was considered to be the order of the day, but because it has been put forward as a solution to the problem of low transmission of interest rates in the banking system.

By linking this rate to market movements of G-Sec yields on a quarterly basis one can guess the final direction of these returns, which could reach a new low over a period of time. Numerically, however, this does not sound convincing.

Higher rates

Outstanding small savings were around ₹6.41 lakh crore as of August 2015, while bank deposits were about ₹90 lakh crore. With small savings being just about 7 per cent of bank deposits it is hard to believe that banks are not in a position to lower interest rates because small savings returns are higher and that there will be a migration.

In fact, within small savings, deposits account for around 64 per cent of total, followed by certificates with 30 per cent and PPF with 7 per cent. If at all there is competition between these forms of savings it would be with post office deposits which would account for just about 4.5 per cent of bank deposits.

Hence, to argue that a savings avenue like post office term deposits, which is less than 5 per cent of the banking system deposits, is potent enough to erode the funds base of banks can be questioned. Within small savings, certificates are contracted savings which have a fixed return when purchased. Here it will be the only incremental certificates that will carry a lower interest rate.

PPF would be the biggest beneficiary for the government as the existing deposits would also get re-priced at the new interest rate structure. PPFs have the advantage of being immobile as the motivation is different, and one keeps putting in the amount of up to ₹150,000 irrespective of the interest rate due to tax benefits. It becomes almost committed — much like the EPF schemes.

Also, there is a limit that cannot be breached and hence household surpluses would have to be invested in either the capital market or bank deposits.

Hence, the argument that small savings can substitute bank deposits may be a bit exaggerated. Further, on an annual basis small savings increase by roughly ₹20,000 crore which is very small compared to bank deposits which would be increasing by between ₹12-14 lakh crore.

More importantly, though it sounds logical to see some substitution between bank and post office deposits, it actually does not happen. One of the reasons is the class of customers tends to be different. Just as how customers do not move out of one bank to another due to the differentials in interest rates on deposits, the same holds even more so in the case of post offices, as the classes involved are different.

Matter of experience

Small savings were meant more for the lower income groups and were targeted at the non-metropolitan level to help in financial inclusion. Therefore, schemes such as monthly income deposits or recurring deposits came into the picture as they appealed to these groups.

Hence, data also reveal that while there are gross receipts coming in, albeit in small quantities, the net incremental savings remains small as there are continuous withdrawals. The small savings schemes have hence not been very appealing to the urban household, which typically is the big saver using bank deposits as the major avenue.

Besides, the customer normally has a complete relation with a bank like access to cards, loans, online facilities, etc. and would feel less inclined to shift to a post office term deposit.

Also the approach to customer service is different in case of post offices and one may not relish the idea of standing in queues to make such deposits.

Lowering of rates is more likely to benefit the government as the lower cost on such instruments means less payout. Based on an increment of ₹20,000 crore, the cost savings for the government at 60 bps cut would be savings of ₹120 crore as interest payments. As a part of this goes to the state governments, this will help reduce the outflow on this score.

Add to this the PPF which gets re-priced immediately, which is a round ₹55,000 crore, and the savings increases by ₹330 crore. The amounts are not really significant for the government.

There are two points here. The first: there is a desperate attempt being made to have interest rates lowered by banks. It started off with the argument that the transmission from RBI policy to banks was sluggish and investment was affected. It was followed with suasion and then was followed by the proposed marginal cost pricing of base rate.

However, banks have been quick to lower deposit rates at a faster pace than the policy rate. While repo came down by 75 bps in FY16, the average deposit rate declined by 92.5 bps. But lending rates came down by just 62.5 bps.

Therefore, the problem has not been so much on banks not being able to lower their deposit rate but reluctance to bring down their base rates. This may be attributed to the present environment of NPA issues as well as higher credit risk perception. It is also true that the non-AAA rated companies continue to pay a much higher mark-up on the base rate due to this reason.

Do we need them?

The second issue relates to the high spreads in the system. The Indian banking system continues to reap one of the highest interest rate spread of around 3.5 per cent (return on advances – cost of deposits) while net interest margin (NII/total assets) is around 2.75 per cent.

Quite clearly, the RBI should also be pressuring banks to be more efficient and reduce these spreads which are sub-optimal and being earned due to oligopolistic power being exerted by the system.

At an ideological level we can pose the question as to whether or not we really require small savings. This is so as most States feel this cost is much higher than the market rates. Deposits can be shifted directly to commercial banks or the new small and payments banks. Certificates can go as long term papers issued by banks.

PPF serves just as an addendum to the existing EPF and VPF with a different interest rate, but serving the same purpose for those who are not salaried. With Post office Bank coming up, this issue would have to be tackled anyway. We do need to think on these lines.