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Should banks pay interest on current accounts as well?

Banks are not paying any interest on balances in current accounts. This has not only deprived banks deposits at cheaper rates but has also resulted in money from current accounts flowing into other markets and mutual funds

The chairman of State Bank of India (SBI), the largest commercial bank in the country, stirred up a hornet’s nest last month by suggesting that banks be allowed to pay interest of at least 2% on current account balances, on which no interest is paid at present. The Reserve Bank of India (RBI) has banned payment of any interest on current account balances since a long time to serve as a cushion for banks to meet the operational costs involved in maintaining these heavily operated accounts held mainly by businesses, traders and industries that have been using the services of banks for all their business needs liberally and free of cost.
 

Last year the RBI liberated savings bank accounts from the regulated interest rate regime and gave freedom to banks to fix their own interest rates on savings accounts. But it is a separate matter that no public sector bank has come forward to offer interest higher than the 4% p.a. fixed during the regulated regime, though a few small private sector banks are offering interest up to 7% p.a. on savings bank accounts.
 

But is there a case for paying interest on current accounts, which are mainly used for business transactions and not for saving purposes
 

Why is SBI asking for liberating current accounts from the regulated regime?
 

Now the only last bastion that remains to be liberated from the regulated interest rate regime is current accounts. And the SBI chief wants this to be deregulated along with the freedom to accept term deposits for periods as low as three days, as RBI permits acceptance of deposits for a minimum of seven days at present. The reasons for such a demand appear to be on the following grounds:
 

1. As the banks do not pay any interest on current account balances, corporates who have temporary surplus funds are tempted to divert such funds to other avenues of liquid investments available in the market.
 

2. Besides, as banks are not allowed to accept term deposits for less than seven days, corporates are not able use the banks for investing their surplus funds for short periods, say less than seven days, and therefore, look for alternative investment avenues, depriving the banks the benefit of such float funds.  
 

3. These surplus funds of corporates, therefore, find their way into the liquid schemes of mutual funds that offer redemption in 24 hours, which is as good as on demand, a facility is not available with banks at present.
 

4. As at the end of February 2013, as per press reports, mutual funds had Rs2,04,398 crore of assets under management (AUM) under liquid schemes and money market schemes of mutual funds and a large part of these funds would have originated from corporates, who would have normally retained such funds with their respective banks, if banks had offered some returns to them on these surplus funds.
 

5. But the irony is that these funds diverted from banks and held by mutual funds come back into the coffers of banks through the medium of call money market, as mutual funds are allowed to lend their surplus cash to banks through what is called as “overnight call money” at the ruling rate of interest. The overnight call money rate at which needy banks borrow from the market, where predominant lenders are banks and mutual funds, was as high as 17 % p.a. during the last week of March 2013, though the average call rate ranged from 7% to 8% during major part of last year.
 

6. If any bank is a regular borrower in the call money market, it is cheaper for the bank to give some interest on current account balances of their customers and retain those funds, instead of borrowing from the call money market at much higher rates, as call money rates depend on the liquidity available in the market  
 

In short, what it means is that by banning the payment of interest on current account balances and restricting acceptance of deposits by banks for a minimum period of seven days, banks have lost by way of flight of deposits from the banking system into other markets and mutual funds, which might have benefitted at the cost of banks. The banks say that this is one of the main reasons for the slowdown in deposit growth during the current year affecting the ability of banks to meet the increased demand for credit, which is growing at a faster pace than deposits.
 

What portion of bank deposits is held in current accounts?
 

As per the latest data published by the RBI, the following is the break up of deposits of scheduled commercial banks (SCBs) as on 31 March 2011.

 

Deposits of SCBs according to type of deposits as on 31 March 2011
 

Amount: Rupees crore

Figures in brackets are percentage to the total deposits     

            

Bank Group Current Savings Term Total
1. SBI Group 1,21,871
(10.6)
4,03,306
(34.9)
6,28,844
(54.5)
1,15,4021
(100)
2. Nationalized
 Banks
3,16,820
(11.1)
7,03,760
(24.6)
1,84,4344
(64.3)
2,86,4924
(100)
3. Foreign Banks: 71,078
(30.3)
39,815
(17.0)
12,3867
(52.7)
2,34,760
(100)
4.Regional Rural
Banks:
8,342
(5.1)
9,0279
(55.2)
6,5074
(39.7)
1,63,695
(100)
5.Private Sector
Banks:
1,52,015
(15.6)
2,29,052
(23.6)
5,91,085
(60.8)
9,72,151
(100)
All SCBs: 6,70,126
(12.4)
14,66,212
(27.2)
32,53,213
(60.4)
53,89,551
(100)
Source: RBI website.

                                                                                  

Impact on the profitability of banks if interest is paid on current accounts
 

It is observed from the above table that current accounts constituted Rs6,70,126 crore which was 12.4 % of the total deposits as on 31 March 2011. Normally, in the banking industry, average deposits for the whole year constitute around 90% of the year end figures. So if we consider the average current deposits of all banks were approximately Rs6 lakh crore for the year 2010-11, and if interest at 2 % was paid on this amount, the total additional interest outgo for the banking sector would have been around Rs12,000 crore for the whole year. However, by deploying fresh funds attracted through current account balances, banks would earn additional interest on these funds, which would not only offset the additional interest outgo, but bring in additional interest income to banks, particularly to those who are active in the overnight call money market and those who are able to expand their credit portfolio profitably. In the normal course, there should not be any adverse impact on the banks’ profitability, if banks are able to raise additional funds through payment of interest and these funds are gainfully deployed through lending operations or otherwise. But in actual practice, the real impact will be different for different banks, depending upon the efficiency with which they deploy their surplus funds instead of keeping them idle in their tills or with the RBI.
 

Another revealing factor from the above table is that foreign banks have bulk of their deposits in current accounts, as 30.3% of their total deposits constituted current accounts, which were available to them virtually free of cost. And this accounts for their much higher profitability ratios, compared to domestic banks. This is again due to the debt-free status of most of the multinational companies which bank mostly with foreign banks and retain the surplus funds with them. The impact on profitability of foreign banks, if interest is paid on current accounts will, therefore, be definitely different, and cannot be equated with domestic banks.
 

Will payment of interest on current accounts de-stabilize banks?
 

There are views aired in the media that allowing banks to pay interest on current account might result in bloating the demand deposits of banks. This in turn may result in mismatch in their asset-liability position which can have a de-stabilising effect on the banks that are heavily dependent on current account balances, which are payable on demand. Theoretically, this may appear plausible, but in actual practice there are a number of checks and balances within which banks are required to operate and RBI keeps an eagle eye on the banks’ operations, keeping the bankers on their toes to ensure that there is no imbalance in their asset-liability position.
 

Besides, at present banks in India are required to keep 4% and 23% of their total deposits as cash reserve ratio and statutory liquidity ratio respectively, which banks may feel will help to serve as a stabilizing factor to some extent for the banking institutions in our country. However, there are bound to be differing views in this matter, as composition of deposits differs from bank to bank, and banks are vying with each other to get a slice of this cake of current accounts, which are considered as a part of the low-cost deposits for the banks.
 

What is the way forward?
 

The RBI has been keeping a steady silence on this matter so far. Coming as it does from the premier bank of our country; it is preferable to see whether it could be a win-win situation for both the banks and its customers. And if it helps to improve the profitability of banks without sacrificing their stability, it certainly requires to be debated with the seriousness it deserves. In the context of the slow growth of deposits in the banking system during the year just gone by, with a view to assess its impact on the profitability of banking industry, the RBI may consider the pros and cons of de-regulating the interest rates on current accounts by making a thorough analysis of the proposal in consultation with all the stake holders and take a pragmatic view in the interest of developing the banking institutions of our country on sound lines.  
 

Other stories from Gurpur   
 

(The author is a banking analyst and he writes for Moneylife under the pen-name ‘Gurpur’)

User

COMMENTS

PRABHAT

4 years ago

IT IS GOOD THINKING

soumya sharma

4 years ago

A very good Analysis......

ashwin bahl

4 years ago

Yes specially now since they even charge us for breathing air once we enter their premises so why shud they be exempted from paying us interest.They are not giving anything free services these days !

REPLY

Vinay Joshi

In Reply to ashwin bahl 4 years ago

It seems you're akin to Cyprus where bank's paid 24%!?

Know the banking system!

Regards,

Vinay Joshi

4 years ago

Gurupur,

I'll not disclose your name.

Will you elucidate the current a/c nos & amounts which are purely transactional maintaining the need.

90%+ c/acs are CC/OD a/cs with different fund based limit sanctions or even non fund based where margins are involved.

In such a scenario where the question arises of paying interest to the vulnerable funds.

Do you mean to say that entity 'X' having negotiated CC int@ 13%, has 100L balance to be paid 2% [the period of holding.]

In such a scenario the floating amounts if not in one a/c may enjoy int in another a/c depriving banks of further margins.

IPO collections will net in.

If all SCB's in c/a/c had - as on 2011- near to Rs7trn, obviously as of 28th March 2013 they would be having at least 30% more.

Then why inspite of all options as of 28th March'13, net borrowing by all banks were Rs1.8trn? Last fiscal day of banking.

of course you are aware about special drawl against SLR, OMO etc; adv tax outgoing etc; etc;

The present SBI, CM has many aspects & is wanting to take on the system. [read FinMin]

Instead he should closely monitor the SBI NPA's, provisioning, age of bad assets which is taking a hit. Liquidity.

He has managed to threaten KFA, what about others? What is his NPA list?

Regards,

REPLY

Gurpur

In Reply to Vinay Joshi 4 years ago

Dear Mr. Joshi, you are right, a substantial part of the amount held in current accounts may not be eligible for interest payment, even if permitted, because of their being earmarked for some specific purposes by the banks. But the exact details of number and amounts held in pure current accounts used for business transactions are not available on RBI website. It is for this reason that the proposal requires deep analysis by RBI who should go into the merits and demerits of the proposal and take a rational decision, so that this matter is decided once for all.

Vinay Joshi

In Reply to Gurpur 4 years ago

Dear Mr.Gurpur,

You are an independent a researcher, visiting faculty member,will you consider a thought idea?

Why India should not draw on credit lines? In the event CAD!?

Hope i'm sounding the right way or rather echoing what you would!?

In 1991 Indian economy was $287B, today the state of Maharashtra has $190B. Then CAD was diff from now.

Regards,

Gurpur

In Reply to Vinay Joshi 4 years ago

Dear Mr. Joshi, you are right, a substantial part of the amount held in current accounts may not be eligible for interest payment, even if permitted, because of their being earmarked for some specific purposes by the banks. But the exact details of number and amounts held in pure current accounts used for business transactions are not available on RBI website. It is for this reason that the proposal requires deep analysis by RBI who should go into the merits and demerits of the proposal and take a rational decision, so that this matter is decided once for all.

Gurpur

In Reply to Vinay Joshi 4 years ago

Dear Mr. Joshi, you are right, a substantial part of the amount held in current accounts may not be eligible for interest payment, even if permitted, because of their being earmarked for some specific purposes by the banks. But the exact details of number and amounts held in pure current accounts used for business transactions are not available on RBI website. It is for this reason that the proposal requires deep analysis by RBI who should go into the merits and demerits of the proposal and take a rational decision, so that this matter is decided once for all.

Seshamani

4 years ago

Banks should pay interest and this should be free for the Banks to decide upon.
The restriction placed on the Banks by the RBI is an artificial one - conservative as usual.
What they may not have figured out is that the money simply has to be moved out of the bank so that there is efficient use. It creates more useless work with no effective result.

PRABHAT

4 years ago

IT IS A GOOD SUGGESTION .
IT IS ALSO SUGGESTED THAT INTEREST ON SAVING A/C ALSO BE INCREASED AND FIXED DEPOSITS BE ISSUED ONLY FOR ONE YEAR AND ABOVE ONLY . IT WILL REDUCE A LOT OF WORK OF THE BANKS .

GAIL enters 2.3mmtpa terminal service agreement with Dominion, but concerns about feedstock remain

The current contract is just for booking terminal capacity. GAIL would need to source feedstock gas and if it is not able to than it will need to pay a capacity charge. To mitigate the risk, GAIL would need to take more stakes in upstream shale gas projects in the US

State-owned gas transmission major GAIL India has announced booking of 2.3 mmtpa LNG terminal service with Dominion from its planned Cove Point LNG liquefaction project in the US. Dominion, which currently has an 11.7 mmtpa re-gas capacity, is planning to convert it to a liquefaction terminal. GAIL has booked 50% of the current 4.6 mmtpa capacity being marketed, as per Nomura Equity Research.

 

Dominion expects that construction on the terminal would begin by 2014, with liquefaction operations projected to start in 2017. GAIL has not indicated the likely liquefaction charges, but Nomura opines that these would be close to $3 per (million metric British thermal unit) mmBtu that GAIL agreed for its contract with Cheniere.

 

Agreement positive from long term; LNG share would increase

According to Nomura Equity Research, giving the large and increasing domestic gas demand supply gap, agreements to tie-up long-term LNG are positive. In recent years, GAIL’s focus has been to tie-up long-term gas, and it has seen significant success like tying-up contracts with Cheniere (3.5mmtpa) and Gazprom (2.5mmtpa). Share of LNG in GAIL current transmission volume is around 30%. “We think once all recently signed contracts come into operation, the share of LNG in GAIL’s domestic transmission portfolio would easily exceed 50%,” Nomura said.

 

Risks higher than GAIL’s other LNG contracts: likely GAIL will take more upstream capacity in the US

Unlike the Cheniere contract (where GAIL is buying Henry hub indexed LNG), the current contract is just for booking terminal capacity. GAIL would need to source feed stock gas and if it is not able to than it will need to pay a capacity charge. To mitigate the risk, it would make sense for GAIL to take more stakes in upstream shale gas projects in the US. GAIL already has a 20% stake in Carrizo’s Eagle Ford acreage, and it would look for more acreage in the Marcellus area close to Cove Point terminal.

 

Early non-Free Trade Agreement (FTA) country export approval by the US government would be key for the liquefaction project to move ahead. For a long period now the debate has been ongoing in the US on the merits/demerits of exporting gas from the US and its impact on the US; particularly from the point of view of the likely impact on domestic gas prices and also the likely impact on the environment.

 

Approval process for non-FTA export has been slow, and in recent years only Cheniere’s Sabine Pass terminal has been given the much sought after permit. There is a long list of nearly 16 project developers seeking export approval from the US Department of Energy (Dominion had made the application in October 2011 and is third on the list).

 

According to Nomura Equity Research, the non-FTA export approval can take time, and may not come through. In addition, there is also a risk that once the export of LNG from the US starts, and domestic gas prices start to increase (which has been a concern by those against exports), there is also some risk that the US could at a later stage stop /curtail gas exports.

 

Near-term concerns in each key business

In the near term, the outlook continues to remain weak for all of GAIL’s key businesses. The government is mulling over a gas price increase for all domestic gas. According to Nomura’s analysts, GAIL, as a user of gas (internal consumption as fuel/feedstock for LPG/petchem production and gas transmission), would be the worst impacted among the oil & gas companies under Nomura’s coverage. Assuming it is not able to pass on any cost increase (or reduce gas costs by increasing PMT volumes for its own consumption), it sees an impact of 15-16% to its FY14F/15F EPS estimates.

 

Even as GAIL continues to add pipelines, the domestic gas volumes declines continue. Domestic production volumes have been declining now for nearly three years and there is low visibility of a turnaround soon.

 

GAIL’s LPG business profitability has eroded due to high and ad-hoc subsidy sharing business. Nomura believes that the company’s upstream subsidy share would increase.

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