India is set to usher in another set of banking reforms in a few months with the Reserve Bank of India (RBI), the central bank, proposing to deregulate savings rates.
This comes after a major overhaul of the way banks fix their lending rates. The RBI is going to enforce a new discipline among banks, requiring them to announce their own base rates, which will work like benchmarks for all lending products.
The so-called base rates will replace the existing benchmark prime lending rate. Indian banks have this so-called benchmark in practice but more often than not they lend, especially to big corporates, at rates far below this rate.
The new regulation, which comes into force from July 1 this year, is expected to bring in the much-needed transparency and competition among banks in pricing their products. This is also likely to tie down banks from offering teaser rate loans, a practice that has become rampant in the mortgage loan segment ever since a bubble burst in India's real estate sector and the slowdown in the domestic economy triggered by the global financial turmoil in 2008 and 2009.
Now in the next stage, RBI plans to deregulate savings rate. At present banks can fix rates only on deposits over Rs 2 lakh (approx $5,000).
"Deregulation of interest rates (including savings rates) is an important way forward for reforms. The base rate system that will come into affect from July 1 is also an important reform method," RBI governor D Subbarao said last week.
"There is now a consensus in the government and RBI that all rates should be deregulated, including the savings bank rate. It is certainly on the anvil. It could either be freed completely or there could be a floor price fixed as threshold, beyond which banks cannot go. We need to decide on the mode of migrating to the new system," RBI deputy governor KC Chakrabarty said in an interview.
Currently, Indian banks offer a fixed interest rate of 3.5 per cent on savings deposits. The RBI has mandated that this rate be calculated on a daily basis effective April 1, 2010.
Bankers say deregulating savings rate will help consumer get a better deal. As the banking space gets competitive with the arrival of a large number of private banks and consolidation among public sector players, banks are looking to raise their levels in savings and current accounts, a source of cheaper liquidity.
And when they get to offer savings rates at their own discretion, many are expected to use them to draw new customers. But these rates may also fluctuate wildly depending on the availability of liquidity. Also it remains to be seen if the new base rate and the proposed deregulation of savings rates will tighten margins so much as to hurt profitability and viability of smaller banks.
Indian banking sector has undergone a huge transformation even since the industry was opened up for private participation and foreign players as part of the broad based economic reforms initiated in 1991. The central bank has since restricted licensing of new foreign players, but the government this year proposed to open licensing of new domestic players.
Last year, the central bank freed use of automated teller machines for bank card holders across banking platforms and ordered banks mandatory accommodate segments of the unbaked population.
The government and the central bank are also in the process of implementing a new mechanism of using banking correspondents, which will use prominent citizens and even grocery shops in villages as dealing points to take banking to far-flung areas.
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