Deregulating SB interest rates without strengthening the banking industry is putting the cart before the horse
The RBI must consider long-pending measures to strengthen the banking system and introduce customer service initiatives that would enable customers to take advantage of the liberalisation in interest rates
As a prelude to deregulating the savings bank interest rate, the Reserve Bank of India (RBI) recently released a discussion paper describing the pros and cons of deregulation and invited feedback from the public on the issue. The deregulation of interest rates on savings bank (SB) accounts without strengthening the banking industry is virtually putting the cart before the horse. In order to assist the banks to smoothly move over to the deregulated regime, the RBI should first take steps to strengthen the banking industry that are long overdue.
The RBI in its discussion paper raised two concerns on deregulation of SB interest rates. First, the possibility of an asset-liability mismatch that could be caused; and second, net interest margins (NIMs) could be affected. It is to meet these two concerns that this article suggests some far-reaching changes in the way banks are regulated and what the RBI can do to strengthen the banking industry, before giving complete autonomy to banks in fixing interest rates on SB and current deposits and certain types of advances.
1. Insurance cover: First and foremost, it is necessary for the RBI to enhance the deposit insurance cover which has been at Rs1 lakh per customer since 1 May 1993. Across the Western world, there has been a steep increase in the deposit insurance cover following the recent financial turmoil. The US Federal Reserve recently raised the insurance cover to $250,000 from $100,000 to maintain stability and public confidence.
In the Indian context, though there have been no bank failures, it is necessary to increase the insurance cover in line with inflation over the last two decades, with a view to creating confidence among the public, who would be disillusioned, once banks begin to quote higher SB interest rates. The present deposit insurance cover should be raised to a level of at least Rs10 lakh, which will not only inspire confidence, but serve the cause of financial inclusion as well.
2. Restore interest on CRR balance: The RBI had in its discussion paper raised concern that deregulation may adversely affect the net interest margin of banks. Banks that are already reeling under the burden of higher operational costs due to increase in the wage structure and pension options, and shrinking margins due to the demand to reduce the spread between the deposit and lending rates, will find it difficult to maintain their profitability if SB interest rates are also deregulated. Without any other source of income to compensate the hike in SB interest rates this is bound to happen on deregulation.
It is here that the RBI should reconsider its earlier decision to completely stop paying interest on CRR balances maintained by banks with the central bank. Till a few years ago, the RBI was paying interest on CRR balances beyond 3%, which was unilaterally and illogically withdrawn and this has affected the profitability of banks considerably. The RBI should restore payment of interest at the appropriate rate, at least on the major part of CRR balances, which will greatly help banks to maintain their profitability.
Alternatively, the RBI should consider reducing CRR to the level of 3%, thereby providing leeway to banks to earn on these funds which are blocked for no fault of theirs. If the RBI wants to monitor money supply to control inflation, it has many other avenues to do so, like open market operations and the SLR route, which would not hurt the banks like the high CRR without interest has.
3. Level playing field: At present, there is no level playing field for public sector and private sector banks. While interest subvention is provided to public sector banks, no such benefit is available to private banks. There is need to permit all private and foreign banks to handle government business, like collecting taxes, placement of government deposits, etc, which will not only be of help to the banks concerned but also to their customers.
4. Expand role of NABARD: The age-old directive on priority-sector lending requires complete overhauling and the whole concept must be reviewed and changed drastically. Lending to the priority sector should be made voluntary and encouraged by incentivising such lending, rather than penalising banks that do not reach the stipulated targets. Incentives like lower CRR and SLR requirements, providing additional funding at a concessional rate from the RBI to the extent of lending to the priority sector, may be considered to encourage banks to continue to lend to these sectors.
Instead of forcefully pushing commercial banks to lend to sectors where they are not comfortable, the RBI should expand the role of NABARD substantially, to lend directly to these preferred sectors by branching out in all the districts of the country in a time bound manner. To hasten this process, regional rural banks can be either merged with NABARD or made subsidiaries, through which direct lending can be made under the authority and control of NABARD. This will considerably lessen the burden on commercial banks, who have to show continued performance to remain in business and raise capital from the market.
5. Asset-liability mismatch: Another area of concern raised by the RBI is the mismatch in liquidity that could be caused by the deregulation of SB interest rates. This requires serious consideration on the part of the RBI, as SB deposits when deregulated may lose the character of a 'core deposit' and would be similar to current deposits, which can move swiftly to where it is invited with higher benefits. To minimise its impact on the liquidity of banks, it is necessary to put in place adequate safeguards, like putting a ceiling on long-terms loans granted by commercial banks, encouraging 'take out financing' by providing certain incentives, and allowing banks to raise long-term funds by giving tax concessions and other incentives.
Apart from strengthening the banks, the RBI should also put in place some customer service initiatives.
1. KYC (know your customer) norms have become a deterrent for financial inclusion, with each branch asking for different documents every time an account is opened. Again, when a customer moves from one bank to another, he has to satisfy the other bank by complying with KYC norms all over again.
To obviate this difficulty, it is advisable to evolve a system similar to the one followed by mutual funds in the country. They have set up a centralised agency, where the record of compliance of KYC norms is maintained and this record is shared by all mutual funds. Thus new customers to a fund do not require to go through the entire KYC process again if they have already complied with the norms when investing with any other mutual fund. CDSL Ventures Ltd, which is the centralised agency for mutual funds in this respect could be used by banks as well, as this would hasten the process of putting in place a reliable and tested mechanism for the banking industry. This would be a boon for customers wanting to move from one bank to another to take the benefit of higher interest rates offered in a competitive environment.
2. Account number portability: Banks should consider providing account number portability (ANP) for customers, on the lines of mobile number portability (MNP). This will help customers move from one bank to another smoothly and without having to change their account numbers, thereby making life easier for them. Care will have to be taken to ensure that portability provides flexibility of transfer of funds under ECS and so on, without any mishaps, as account portability is more onerous than simple MNP. It will require careful planning and cautious implementation, with due regard to the nature of the work involved.
3. Synchronise customer ID with UID: With the introduction of unique identification numbers (UID), it would be necessary to synchronise customer IDs allotted by banks with UID numbers, so as to better serve the interests of customers in the long run. The project must work in tandem with the account number portability proposal, as they serve identical objectives so far as customers are concerned.
4. Dematerialilse deposit receipts: Many banks in India still issue deposit receipts on security paper, spending considerable amount of money in this process. They could save this wasteful expenditure through dematerialisation of deposit receipts, while issuing only paper receipts like airline tickets, which are now the accepted norm. Unless the RBI advises banks to move over to the easier method of paper receipts, many banks would shy away from this innovation. It is up to the RBI to consider making it mandatory for all banks to follow a uniform system of deposit receipts in ordinary paper form instead of security paper. This would not only be customer friendly, but also a positive step in the direction of conservation of the environment.
(The author is a banking and financial consultant. He writes for Moneylife under the pen name 'Gurpur'.)