Disincentivising savings

Subject: Economy

Context:

There has been a sharp fall in deposit rates due to aggressive rate cuts by banks in response to the Reserve Bank of India’s (RBI) reduction in the benchmark rates. This coupled with a rise in consumer prices have pulled real interest rates into negative territory, disincentivising savings.

Concept Builder:

Real interest Vs Nominal Interest

A real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor. A nominal interest rate refers to the interest rate before taking inflation into account

What has happened?

Since this March, fixed deposit rates have fallen by 100-125 basis points across many banks, even higher in some cases. In fact, deposit rates fell significantly in 2019 and were on a free fall in the beginning of this year, even before the RBI embarked on its fast-paced rate easing cycle since March.

Why banks are reducing deposit rates?

• In a falling rate scenario, banks are often more quick to cut deposit rates than lending rates. In the current scenario, when there is surplus liquidity and weak credit growth Banks have reduced deposits rate to cushion themselves.
• Banks have turned highly risk averse to lending and even cautious to investing in government bonds (fearing mark-to-market loss).
• Hence, to cushion the impact of lower interest income on margins, banks have been cutting deposit rates significantly. For eg: SBI had cut its savings deposit rate to 2.7 per cent last month (for deposits up to ₹1 lakh).

What’s the effect?

Savers are stuck with bank deposit rates that are at near two-decade low levels. Currently (as of mid-June), public sector banks (PSBs) on an average offer 5.2-5.45 per cent on their 3-5 year deposits. The last time deposit rates were near around these levels were in 2003 and 2004.