On the 31st of July SBI announced a cut in deposit rates for small savings accounts up to a deposit value of Rs.1 crore. Currently, all savings accounts of SBI pay an annual interest of 4% on the minimum average balance between the 1st and the 10th of the month. Effective immediately, SBI has decided to cut these rates from 4% to 3.5% for savings accounts up to a deposit value of Rs. 1 crore. For high denomination deposits of above Rs. 1 crore, the old rate of 4% will continue. The shift is significant because currently there are private banks like Kotak Bank, Yes Bank and RBL Bank that are paying higher rates of 6-7% on savings accounts. What does this mean for interest rates in general and for SBI in particular?
Impact of the move on SBI depositors
According to early estimates, the move to cut rates on savings deposits up to Rs. 1 crore will impact nearly 90% of the depositors of SBI. It needs to be remembered that SBI already has the most impressive CASA ratio of nearly 43.5% and all the other banks are lagging behind on this measure. SBI currently has a savings deposit base of nearly Rs.9 trillion ($140 billion). Considering that nearly 90% of the deposits are subject to this rate cut of 50 basis points, the impact on a base of $140 billion is going to be huge. Savings deposit rates were at a level of 3.5% in case of SBI between 2003 and 2011. However, post 2011 the rates on SBI savings deposits were revised upwards to 4% and has stayed there since then.
Understanding this move through the lens of demonetization…
To understand the logic behind this move, one needs to understand the aftermath of the demonetization drive that was launched in last November. When demonetization forced all individuals to necessarily route their funds through banks, the result was a surge in deposits. According to estimates put out by the RBI, the banking sector in India saw an additional inflow of nearly Rs.7 trillion during the demonetization period and that resulted in a surge in bank deposits, with SBI being the biggest beneficiary. Post demonetization, there has not been any significant withdrawal since the government has put severe restrictions on cash transactions. As a result most of the deposits have stayed back. This has created a piquant situation for banks like SBI. On the one hand credit demand was not picking up due to weak industrial growth and a robust debt market which led to industry raising money without opting for bank loans. Secondly, the banks were required to pay interest on these massive deposits but were not earning commensurately on their loan books. The gap had to be bridged and the best way for SBI was to cut the deposit rates on savings accounts by 50 basis points.
A choice between the devil and the deep sea…
That is what it actually was; a choice between the devil and the deep sea. The inflation has come down sharply with retail inflation below 2% and food inflation in negative territory. With a good monsoon and a bumper Kharif crop expected in 2017, the food inflation is likely to stay benign. The large banks like SBI were left with two choices. They could raise the MCLR (Marginal Cost Based Lending Rate), which was not feasible at a time when credit demand is already at an all-time low. The other option was to cut the rates of interest on deposits, which is what SBI has done. With deposits being the elastic compared to loan demand, it appears like more banks may follow suit to protect their spreads in the lending business.
What could be the larger implications of this move?
Let us first look at the implications from the banking industry perspective. Post 2011, when savings rate were deregulated by the RBI, most PSU banks have preferred to follow the lead taken by SBI. While private banks with smaller deposit base may choose to maintain their higher savings rates, we expect most PSU banks to follow suit. Hence we may see a situation wherein bank savings rates will come down across the board. While the spread and reach of the PSU banks is still a major advantage, it is now possible to open a virtual banking account from anywhere. That could mean that location and spread could actually be redundant.
The bigger implication of this move is that it is an indicator of the direction of interest rates. In the last policy, the Monetary Policy Committee (MPC) had hinted that inflation for the year may be below the initial expectations. The move by SBI to cut savings rates is almost an affirmation of the view that rates are headed downward. Whether the rate cut will happen in the August policy or not remains to be seen. However, the SBI move clearly underscores the conviction that interest rates and yields in India are headed downward.
Last month, Dr. Viral Acharya (RBI Deputy Governor) had hinted at a shift in savings from real assets to financial assets. This was visible post demonetization. With the latest move by the SBI to cut rates, more people may prefer the higher alpha of mutual funds and equities compared to traditional banking deposits. For the capital market players, it may finally be time to rejoice!