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India Banks
Savings rate deregulation? – Be
prepared for an all-out fight
Deregulation to compress margins in the near term
We believe the savings rate deregulation, if it happens, could result in banks’
margins coming under severe pressure in the near term as some irrational
competition could occur in the market and we could see banks, especially those
with poor deposit franchises, trying to woo customers by offering attractive rates.
The liquidity situation may not be the key factor determining savings rates in the
near term in our view. There could also be some ALM mismatches in the near
term due to savings deposits being switched from one bank to other as the
banks start competing. Assuming all else remains constant, margins could come
down on average by 25-30bps for every 100bps increase in savings rate, by our
assumptions.
High fragmentation, renewed focus of PSU banks on CASA
the key culprits
The Indian banking industry is highly fragmented, and with new banking licenses
also likely to be offered, we believe there could be increased competition. New
entrants and those banks with weak funding franchises, in particular, could resort
to desperate measures to attract savings deposits. PSU banks have also been
given well-defined CASA targets by the government, which was not the case in
the past, and having a high CASA ratio is an important performance metric for
the PSU banks’ top management. This is evident in the renewed focus of all the
PSU banks on CASA over the past two years.
Regional experience reveals that savings rate deregulation
impacted bank market values negatively
A study on deregulation of the savings rate in Hong Kong reveals that
deregulation wasn’t taken well by the markets, and bank market values declined
post announcement of the regulation. Larger banks were impacted more than
smaller ones. The conclusion was that the regulated savings rate subsidised
bank earnings at the expense of depositors. However interactions with our
regional analysts suggest that over the longer term, offering higher interest rates
acted as a poor hook to capture customers, and service levels and accessibility
were more key in determining the ability to garner savings deposits.
Large PSU banks impacted the most
Contrary to the popular perception that private banks, especially HDFC Bank,
will be impacted the most by savings rate deregulation, it’s likely to be the large
PSU banks that are impacted the most. Firstly the savings deposit proportion
across all banks is not materially different. HDFC Bank’s exceptionally high
CASA is mainly due to its higher current account balance. Secondly the
contribution of NII (Net Interest Income) to overall income and profits for PSU
banks is higher than for private banks. Private Banks have a large dependence
on non-interest income. Hence the earnings impact on average for the large
PSU banks is around 13% for every 100bps increase in savings rate compared
to 8% for private banks. Amongst PSU banks, SBI is impacted the most due to
its very high savings deposit proportion of 38%, followed by PNB at 31%. Among
private banks, the earnings impact for the top 3 – HDFC Bank, ICICI Bank and
Axis Bank – is more or less similar.
Savings rate deregulation? – Be prepared
for an all-out fight
Margins to come down due to competition in the near term
We believe the savings rate deregulation, if it happens, could result in banks’ margins coming
under severe pressure in the near term as there could be some irrational competition in the
market, and we could see banks, especially those with low CASA, trying to woo customers by
offering attractive rates. Assuming all else remains constant, margins could come down on
average by 25-30bps for every 100bps increase in savings rate by our assumptions.
Some of the reasons why we believe, in the near term, that savings rate deregulation could
push up interest rates are as follows:
The Indian banking system is very fragmented and we believe deregulation could
result in banks, especially those with weaker deposit franchises, trying to jack up rates
With more banking licenses likely to be awarded, the new entrants could be desperate
and could resort to irrational behaviour in the near term
Over the past few years PSU banks have become aggressive with respect to their
CASA mobilisation. They have been given explicit targets by the Government, unlike
2-3 years ago. This is also reflected in their rapid scale-up of liabilities franchises over
the past few years.
The CASA ratio is also an important performance metric for the PSU banks’ top
management.
Though corporate deposits with less than a 30day maturity are available at 4-5%, we
don’t believe that a bank can replace its entire savings account proportion with
corporate deposits. Moreover, it would further result in significant ALM mismatches as
savings accounts are sticky and banks can quite often prove the longer term nature of
such liabilities.
Though liquidity conditions would eventually determine rates at the shorter end of the
curve, we believe there could be a tendency by banks in the near term to keep rates at
irrational levels in order to attract savings deposits even if there is plenty of liquidity.
Acquisition of savings deposits by offering higher rates could be perceived as a good
customer acquisition strategy that banks can resort to so that they can eventually
cross-sell other products.
Free market pricing could result in savings rate going up by 150bps
In an ideal scenario assuming there is no irrational competition the savings rate should mirror
short term rates i.e. rates at the lower end of the yield curve. If we take SBI’s 15-30 day
deposit rate as the reference point for free market pricing of savings deposits, then interest on
savings deposits is currently around 150bps lower than SBI’s 15-30 day deposit rate of 5%.
Longer term profitability would not be impacted much in our view
Over the longer term, we believe profitability is unlikely to be impacted structurally for banks
as we believe the deregulation will result in more product innovation and would also enable
banks to price their savings products appropriately. Service levels and accessibility would be
other key factors that we expect would eventually determine banks’ ability to attract savings
deposits. Higher rates alone cannot be the hook to attract customers as savings accounts are
mainly transactional. Banks could also eventually fix hidden charges to protect their margins.
Eventually, as discussed above, the savings rate would be a function of liquidity in the market
and free market pricing would then price these deposits in accordance with the liquidity
situation prevailing. For example, if we take 15-30 deposits as the closest proxy to free
market pricing of the savings deposit rate, we see that the rates were exceptionally low when
liquidity was abundant and the current tight liquidity has resulted in a sharp 250bps upward
movement in this bucket. The chart below reflects the liquidity situation (bank borrowings from
RBI) vs. SBI’s 15-30 day deposit rate observed over the period. However as discussed
above, in the interim there could be an upward bias on rates irrespective of the liquidity
dynamics.
PSU banks impacted the most, HDFC Bank
amongst private banks
PSU banks affected more than private sector banks
Contrary to the popular perception that private banks, especially HDFC Bank, will be
impacted the most by savings rate deregulation, we believe it’s actually the large PSU banks
that would be impacted the most. Firstly, the savings deposit proportion among banks is not
materially different. HDFC Bank’s exceptionally high CASA is mainly due to its higher current
account balance. Secondly, the contribution of NII (Net Interest Income) to overall income and
profits for PSU banks is higher than for private banks. Private banks have a large
dependence on non-interest income. Hence the earnings impact on average for the large
PSU banks is higher than private sector banks due to margin compression arising out of
deregulation of the savings rate.
Earnings impact: PSUs around 13% on average and private banks
around 8% for every 100bps increase
For PSU banks, the earnings impact is around 13% for every 100bps increase in savings rate
compared to 8% for private banks. Amongst PSU banks, SBI is impacted the most due to its
very high savings deposit proportion of 38%, followed by PNB. Among private banks, the
earnings impact for the top 3 – HDFC Bank, ICICI Bank and Axis Bank – is more or less
similar.
Regional experience – Savings rate
deregulation hampered stock performance
HK savings rate deregulation study suggests bank stocks reacted
negatively
Background – Savings rate deregulation happened in two stages
The following table provides the key event dates associated with the deregulation of deposit
interest rate ceilings in Hong Kong which span a six-year period. It can be described as a
two-stage process that is neatly separated by the 1997 takeover of Hong Kong by China.
Stage one of the deregulation occurred between 1994 and 1995 when Hong Kong was still a
British territory. The second stage took place between 1998 and 2000 after the sovereignty of
Hong Kong was returned to China.
Stage one – Partial deregulation
During the first stage of deregulation, the HKMA deregulated time deposits of greater than 7
days maturity but didn’t touch demand and savings deposits and time deposits with less than
7 days’ maturity.
Stage two – complete deregulation
On May 30, 2000, the HKMA announced the deregulation of the remaining time deposits with
a maturity of less than 7 days. More significantly, it also announced that the interest rate caps
on demand and savings deposits would be removed in July 2001. Successful implementation
of these two phases of interest rate deregulation completely abolished the 36-year-old IRRs
(Interest rate rules). This was a significant announcement because, as of 1999, total HK$
demand and savings deposits accounted for 32% of total HK$ deposits held by licensed
banks.
Back in 1994 when time deposits were partially deregulated, HK$ time deposits subject to the
IRRs constituted only 4% of HK$ deposits. Thus, compared to the deregulation of time
deposits, the deregulation of demand and savings deposit rates represented a much more
important economic event.
Striking similarity of HK market with Indian market in terms of competition
While there were 156 licensed banks in Hong Kong at the end of 1999, 97 of them were
single-office, wholesale financial institutions that did not engage in retail deposit taking.
Almost all of these wholesale institutions were branches or representative offices of foreign
banks that established a presence in this Asian financial centre. Of the remaining 59 multibranch
banks, 46 were wholly owned subsidiaries of foreign financial institutions. This left
only 13 locally incorporated commercial banks whose revenues derived largely from their
Hong Kong operations. All of the 13 Hong Kong banks were publicly held and their common
stocks were traded on the stock exchange. These 13 listed banks, including some of the
largest institutions in Hong Kong, together accounted for 48% of all deposits held by licensed
banks in 1999.
This clearly shows that the HK market was as fragmented as the Indian market, which also
has around close to 40+ domestic banks and 60+ foreign banks (with their branch offices).
Study done by Simon Kwan revealed negative impact on bank market values post
deregulation
The study done by Mr. Kwan from the Federal Bank of San Francisco revealed that on
average the total abnormal return (of stock prices of listed banks) due to interest rate
deregulation was around negative 4%. There is some evidence that large banks and banks
with high deposit-to-asset ratios suffered a bigger drop in value, suggesting that these banks
enjoyed a bigger subsidy under the IRRs. The key conclusions in this study are summarised
below
In the first stage, though only a small fraction of the total deposit base was freed from
the IRRs (interest rate rules), all the evidence suggests that banks earned rents under
the IRRs and news about potential relaxation of the rules lowered bank values.
After the sovereignty of Hong Kong was returned to China, a series of events led the
new Hong Kong government to abolish the 36-year-old IRRs completely. Compared to
the first stage, these were more significant economic events as the IRRs on the more
important demand and savings deposits would be removed. On average, bank stocks
were found to suffer a total AR (abnormal return) of around negative 4%. The
significant decline in bank market values due to the interest rate deregulation confirms
that the IRRs subsidized bank earnings at the expense of depositors. Removal of
deposit rate restrictions lowered bank profits and hence bank shareholders’ wealth.
Finally, there is some evidence that the effects of the interest rates deregulation on
bank stock returns were proportional to bank size and the deposit-to-asset ratio. The
results suggest that large banks and banks with high deposit-to-asset ratios earned a
larger subsidy under the IRRs than small banks and banks with relatively less
deposits.
Experience in other markets – US and UK
The deregulation of deposit interest rates in the US has been studied extensively in banking
literature. For example, Dann and James (1982) found that stockholder-owned savings and
loan associations (S&Ls) experienced statistically significant declines in equity market values
at the announcement of the removal of rate ceilings on certain consumer certificate accounts
and the introduction of short-term variable rate money market certificates, suggesting that
S&Ls had earned economic rents from interest rate restrictions.
As far as the UK is concerned, our UK colleague Edward Firth indicates that in broad terms
current accounts do not compete on interest rates. Banks have tried offering higher rates but
generally it proves to be a poor hook with which to attract customers. Service quality,
availability of overdraft and fee charges are the key drivers in this market, with customers
generally only moving when their existing bank messes something up rather than when they
are attracted by better rates. This dynamic changed a little during the internet boom, but
most customers either didn't move or have returned to one of the high street providers.
Appendix I – Comments of various banking
industry personnel/experts
In this section we present below comments from various experts from the banking industry.
Dr D Subbarao, RBI Governor
All interest rates except those on export credit, NRI deposits and savings bank (SB) accounts
have been deregulated. There are several pros and cons of the deregulation and these needs
to be discussed at length in order to arrive at a consensus. SB accounts comprise almost
25% of banks' total liabilities and this is still regulated and has remained constant at 3.5% for
the last seven years since March 2003. Despite the change in monetary policy rates, this 25%
remains unchanged. It is therefore difficult to assess the extent of impact of monetary policy
changes. While deregulation would give more flexibility to banks, lead to product innovation
and allow banks to have access to a larger base of savings thereby enabling them to handle
asset liability issues, it might, however, discourage banks to open accounts with low balance
thereby working against the principle of financial inclusion and a possible decline in interest
rates might also have an adverse impact on the vulnerable sections of society. (Source:
Hindubusiness Line)
Mr Aditya Puri, MD, HDFC Bank
Excerpts from interview with a news channel (Source: Moneycontrol)
Q: Very soon perhaps we are going to have the savings rate deregulated. How much
will it hurt HDFC Bank? How much do you think your margins can be affected, even if
temporarily?
A: If the savings rate is freed in a normal environment, the rate of interest on savings will go
down. After the initial flurry of everybody trying to take market share, the rate will go down
because at 3.5% it becomes an overnight deposit with a 2.5% servicing cost. One can get a
30-day deposit at 4%.
Q: If that was the case, why is the entire banking industry lobbying against it?
A: Banking industry is not lobbying against it. To break even on a savings account, one needs
a balance in that account of somewhere between Rs.7, 500-10,000. Add a 3% interest rate,
you make it to 5%—to break even you will need Rs.12, 500. What will happen is that the
charges that they charge for cheques, the charges that they charge in terms of giving you free
ATM (automatic teller machine), the balance requirements, transfers etc will all go up.
Number two, I have an option saying that I will just take a 30-day fixed deposit rather than the
savings account. There is no free lunch for the banks but there is no free lunch for you as well
as the market and forces have to be realistic. On behalf of the banking industry, I would like to
say that we are always for a fair deal for the customer. We are not against savings rate
deregulation. Deregulation has to be under normal circumstances. If you do it under tight
liquidity, that’s what we are all saying is an issue. We want a clear understanding that if you
deregulate then you will have to deregulate charges as well.
Q: You would say don’t do a savings rate deregulation unless the inter-bank rate is
operating at the reverse repo window?
A: That’s one way of putting it. I am just saying don’t do it in an atmosphere of scarcity. If it is
done in an atmosphere of scarcity, it could always be Rs400bn. A 1% net demand and time
liabilities shortage could always be there, that is steady state.
Q: But you won’t get more balances in the savings account.
A: What you will also do is, you will make saving accounts volatile for the banks, among the
system and you will completely stop any term lending by banks.
Q: Term lending would stop?
A: Naturally. If I don’t want an asset liability mismatch and I can’t prove that savings have got
stability with me, then it will have to be classified in the overnight bucket.
Mr O P Bhatt, Chairman, SBI
Within the savings bank product, there could be a range of sub-products offering different
facilities to the customer depending upon what kind of business they have with the bank. So,
while it would be very good for the customer, for the bank it would be challenging to retain
their share of CASA. (Source: Moneycontrol)
Ms Shikha Sharma, MD and CEO, Axis Bank
Deregulation is unlikely to impact margins in a big way. It will give greater flexibility in product
design. The savings account is the operating account for the customer and to the extent that
the customer is interest sensitive on what he does with the deposits, the seven day deposit
allows him to reflect that any way today. The seven day deposit is a deregulated rate.
(Source: Moneycontrol)
Mr Rana Kapoor, MD, Yes Bank (YES IN, CMP Rs273, Unrated)
Deregulating savings rates will benefit the consumer most of all. After the recent change in
moving towards a daily interest rate computation, the consumer is effectively gaining 1%.
From an average cost of 2.5% on a savings account, the banks are now paying 3.5% and its
sticky, stable money and long-term money. Banks should be permitted to actually free up
these rates and offer more market based savings rate. (Source: Moneycontrol)
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Banks
Savings rate deregulation? – Be
prepared for an all-out fight
Deregulation to compress margins in the near term
We believe the savings rate deregulation, if it happens, could result in banks’
margins coming under severe pressure in the near term as some irrational
competition could occur in the market and we could see banks, especially those
with poor deposit franchises, trying to woo customers by offering attractive rates.
The liquidity situation may not be the key factor determining savings rates in the
near term in our view. There could also be some ALM mismatches in the near
term due to savings deposits being switched from one bank to other as the
banks start competing. Assuming all else remains constant, margins could come
down on average by 25-30bps for every 100bps increase in savings rate, by our
assumptions.
High fragmentation, renewed focus of PSU banks on CASA
the key culprits
The Indian banking industry is highly fragmented, and with new banking licenses
also likely to be offered, we believe there could be increased competition. New
entrants and those banks with weak funding franchises, in particular, could resort
to desperate measures to attract savings deposits. PSU banks have also been
given well-defined CASA targets by the government, which was not the case in
the past, and having a high CASA ratio is an important performance metric for
the PSU banks’ top management. This is evident in the renewed focus of all the
PSU banks on CASA over the past two years.
Regional experience reveals that savings rate deregulation
impacted bank market values negatively
A study on deregulation of the savings rate in Hong Kong reveals that
deregulation wasn’t taken well by the markets, and bank market values declined
post announcement of the regulation. Larger banks were impacted more than
smaller ones. The conclusion was that the regulated savings rate subsidised
bank earnings at the expense of depositors. However interactions with our
regional analysts suggest that over the longer term, offering higher interest rates
acted as a poor hook to capture customers, and service levels and accessibility
were more key in determining the ability to garner savings deposits.
Large PSU banks impacted the most
Contrary to the popular perception that private banks, especially HDFC Bank,
will be impacted the most by savings rate deregulation, it’s likely to be the large
PSU banks that are impacted the most. Firstly the savings deposit proportion
across all banks is not materially different. HDFC Bank’s exceptionally high
CASA is mainly due to its higher current account balance. Secondly the
contribution of NII (Net Interest Income) to overall income and profits for PSU
banks is higher than for private banks. Private Banks have a large dependence
on non-interest income. Hence the earnings impact on average for the large
PSU banks is around 13% for every 100bps increase in savings rate compared
to 8% for private banks. Amongst PSU banks, SBI is impacted the most due to
its very high savings deposit proportion of 38%, followed by PNB at 31%. Among
private banks, the earnings impact for the top 3 – HDFC Bank, ICICI Bank and
Axis Bank – is more or less similar.
Savings rate deregulation? – Be prepared
for an all-out fight
Margins to come down due to competition in the near term
We believe the savings rate deregulation, if it happens, could result in banks’ margins coming
under severe pressure in the near term as there could be some irrational competition in the
market, and we could see banks, especially those with low CASA, trying to woo customers by
offering attractive rates. Assuming all else remains constant, margins could come down on
average by 25-30bps for every 100bps increase in savings rate by our assumptions.
Some of the reasons why we believe, in the near term, that savings rate deregulation could
push up interest rates are as follows:
The Indian banking system is very fragmented and we believe deregulation could
result in banks, especially those with weaker deposit franchises, trying to jack up rates
With more banking licenses likely to be awarded, the new entrants could be desperate
and could resort to irrational behaviour in the near term
Over the past few years PSU banks have become aggressive with respect to their
CASA mobilisation. They have been given explicit targets by the Government, unlike
2-3 years ago. This is also reflected in their rapid scale-up of liabilities franchises over
the past few years.
The CASA ratio is also an important performance metric for the PSU banks’ top
management.
Though corporate deposits with less than a 30day maturity are available at 4-5%, we
don’t believe that a bank can replace its entire savings account proportion with
corporate deposits. Moreover, it would further result in significant ALM mismatches as
savings accounts are sticky and banks can quite often prove the longer term nature of
such liabilities.
Though liquidity conditions would eventually determine rates at the shorter end of the
curve, we believe there could be a tendency by banks in the near term to keep rates at
irrational levels in order to attract savings deposits even if there is plenty of liquidity.
Acquisition of savings deposits by offering higher rates could be perceived as a good
customer acquisition strategy that banks can resort to so that they can eventually
cross-sell other products.
Free market pricing could result in savings rate going up by 150bps
In an ideal scenario assuming there is no irrational competition the savings rate should mirror
short term rates i.e. rates at the lower end of the yield curve. If we take SBI’s 15-30 day
deposit rate as the reference point for free market pricing of savings deposits, then interest on
savings deposits is currently around 150bps lower than SBI’s 15-30 day deposit rate of 5%.
Longer term profitability would not be impacted much in our view
Over the longer term, we believe profitability is unlikely to be impacted structurally for banks
as we believe the deregulation will result in more product innovation and would also enable
banks to price their savings products appropriately. Service levels and accessibility would be
other key factors that we expect would eventually determine banks’ ability to attract savings
deposits. Higher rates alone cannot be the hook to attract customers as savings accounts are
mainly transactional. Banks could also eventually fix hidden charges to protect their margins.
Eventually, as discussed above, the savings rate would be a function of liquidity in the market
and free market pricing would then price these deposits in accordance with the liquidity
situation prevailing. For example, if we take 15-30 deposits as the closest proxy to free
market pricing of the savings deposit rate, we see that the rates were exceptionally low when
liquidity was abundant and the current tight liquidity has resulted in a sharp 250bps upward
movement in this bucket. The chart below reflects the liquidity situation (bank borrowings from
RBI) vs. SBI’s 15-30 day deposit rate observed over the period. However as discussed
above, in the interim there could be an upward bias on rates irrespective of the liquidity
dynamics.
PSU banks impacted the most, HDFC Bank
amongst private banks
PSU banks affected more than private sector banks
Contrary to the popular perception that private banks, especially HDFC Bank, will be
impacted the most by savings rate deregulation, we believe it’s actually the large PSU banks
that would be impacted the most. Firstly, the savings deposit proportion among banks is not
materially different. HDFC Bank’s exceptionally high CASA is mainly due to its higher current
account balance. Secondly, the contribution of NII (Net Interest Income) to overall income and
profits for PSU banks is higher than for private banks. Private banks have a large
dependence on non-interest income. Hence the earnings impact on average for the large
PSU banks is higher than private sector banks due to margin compression arising out of
deregulation of the savings rate.
Earnings impact: PSUs around 13% on average and private banks
around 8% for every 100bps increase
For PSU banks, the earnings impact is around 13% for every 100bps increase in savings rate
compared to 8% for private banks. Amongst PSU banks, SBI is impacted the most due to its
very high savings deposit proportion of 38%, followed by PNB. Among private banks, the
earnings impact for the top 3 – HDFC Bank, ICICI Bank and Axis Bank – is more or less
similar.
Regional experience – Savings rate
deregulation hampered stock performance
HK savings rate deregulation study suggests bank stocks reacted
negatively
Background – Savings rate deregulation happened in two stages
The following table provides the key event dates associated with the deregulation of deposit
interest rate ceilings in Hong Kong which span a six-year period. It can be described as a
two-stage process that is neatly separated by the 1997 takeover of Hong Kong by China.
Stage one of the deregulation occurred between 1994 and 1995 when Hong Kong was still a
British territory. The second stage took place between 1998 and 2000 after the sovereignty of
Hong Kong was returned to China.
Stage one – Partial deregulation
During the first stage of deregulation, the HKMA deregulated time deposits of greater than 7
days maturity but didn’t touch demand and savings deposits and time deposits with less than
7 days’ maturity.
Stage two – complete deregulation
On May 30, 2000, the HKMA announced the deregulation of the remaining time deposits with
a maturity of less than 7 days. More significantly, it also announced that the interest rate caps
on demand and savings deposits would be removed in July 2001. Successful implementation
of these two phases of interest rate deregulation completely abolished the 36-year-old IRRs
(Interest rate rules). This was a significant announcement because, as of 1999, total HK$
demand and savings deposits accounted for 32% of total HK$ deposits held by licensed
banks.
Back in 1994 when time deposits were partially deregulated, HK$ time deposits subject to the
IRRs constituted only 4% of HK$ deposits. Thus, compared to the deregulation of time
deposits, the deregulation of demand and savings deposit rates represented a much more
important economic event.
Striking similarity of HK market with Indian market in terms of competition
While there were 156 licensed banks in Hong Kong at the end of 1999, 97 of them were
single-office, wholesale financial institutions that did not engage in retail deposit taking.
Almost all of these wholesale institutions were branches or representative offices of foreign
banks that established a presence in this Asian financial centre. Of the remaining 59 multibranch
banks, 46 were wholly owned subsidiaries of foreign financial institutions. This left
only 13 locally incorporated commercial banks whose revenues derived largely from their
Hong Kong operations. All of the 13 Hong Kong banks were publicly held and their common
stocks were traded on the stock exchange. These 13 listed banks, including some of the
largest institutions in Hong Kong, together accounted for 48% of all deposits held by licensed
banks in 1999.
This clearly shows that the HK market was as fragmented as the Indian market, which also
has around close to 40+ domestic banks and 60+ foreign banks (with their branch offices).
Study done by Simon Kwan revealed negative impact on bank market values post
deregulation
The study done by Mr. Kwan from the Federal Bank of San Francisco revealed that on
average the total abnormal return (of stock prices of listed banks) due to interest rate
deregulation was around negative 4%. There is some evidence that large banks and banks
with high deposit-to-asset ratios suffered a bigger drop in value, suggesting that these banks
enjoyed a bigger subsidy under the IRRs. The key conclusions in this study are summarised
below
In the first stage, though only a small fraction of the total deposit base was freed from
the IRRs (interest rate rules), all the evidence suggests that banks earned rents under
the IRRs and news about potential relaxation of the rules lowered bank values.
After the sovereignty of Hong Kong was returned to China, a series of events led the
new Hong Kong government to abolish the 36-year-old IRRs completely. Compared to
the first stage, these were more significant economic events as the IRRs on the more
important demand and savings deposits would be removed. On average, bank stocks
were found to suffer a total AR (abnormal return) of around negative 4%. The
significant decline in bank market values due to the interest rate deregulation confirms
that the IRRs subsidized bank earnings at the expense of depositors. Removal of
deposit rate restrictions lowered bank profits and hence bank shareholders’ wealth.
Finally, there is some evidence that the effects of the interest rates deregulation on
bank stock returns were proportional to bank size and the deposit-to-asset ratio. The
results suggest that large banks and banks with high deposit-to-asset ratios earned a
larger subsidy under the IRRs than small banks and banks with relatively less
deposits.
Experience in other markets – US and UK
The deregulation of deposit interest rates in the US has been studied extensively in banking
literature. For example, Dann and James (1982) found that stockholder-owned savings and
loan associations (S&Ls) experienced statistically significant declines in equity market values
at the announcement of the removal of rate ceilings on certain consumer certificate accounts
and the introduction of short-term variable rate money market certificates, suggesting that
S&Ls had earned economic rents from interest rate restrictions.
As far as the UK is concerned, our UK colleague Edward Firth indicates that in broad terms
current accounts do not compete on interest rates. Banks have tried offering higher rates but
generally it proves to be a poor hook with which to attract customers. Service quality,
availability of overdraft and fee charges are the key drivers in this market, with customers
generally only moving when their existing bank messes something up rather than when they
are attracted by better rates. This dynamic changed a little during the internet boom, but
most customers either didn't move or have returned to one of the high street providers.
Appendix I – Comments of various banking
industry personnel/experts
In this section we present below comments from various experts from the banking industry.
Dr D Subbarao, RBI Governor
All interest rates except those on export credit, NRI deposits and savings bank (SB) accounts
have been deregulated. There are several pros and cons of the deregulation and these needs
to be discussed at length in order to arrive at a consensus. SB accounts comprise almost
25% of banks' total liabilities and this is still regulated and has remained constant at 3.5% for
the last seven years since March 2003. Despite the change in monetary policy rates, this 25%
remains unchanged. It is therefore difficult to assess the extent of impact of monetary policy
changes. While deregulation would give more flexibility to banks, lead to product innovation
and allow banks to have access to a larger base of savings thereby enabling them to handle
asset liability issues, it might, however, discourage banks to open accounts with low balance
thereby working against the principle of financial inclusion and a possible decline in interest
rates might also have an adverse impact on the vulnerable sections of society. (Source:
Hindubusiness Line)
Mr Aditya Puri, MD, HDFC Bank
Excerpts from interview with a news channel (Source: Moneycontrol)
Q: Very soon perhaps we are going to have the savings rate deregulated. How much
will it hurt HDFC Bank? How much do you think your margins can be affected, even if
temporarily?
A: If the savings rate is freed in a normal environment, the rate of interest on savings will go
down. After the initial flurry of everybody trying to take market share, the rate will go down
because at 3.5% it becomes an overnight deposit with a 2.5% servicing cost. One can get a
30-day deposit at 4%.
Q: If that was the case, why is the entire banking industry lobbying against it?
A: Banking industry is not lobbying against it. To break even on a savings account, one needs
a balance in that account of somewhere between Rs.7, 500-10,000. Add a 3% interest rate,
you make it to 5%—to break even you will need Rs.12, 500. What will happen is that the
charges that they charge for cheques, the charges that they charge in terms of giving you free
ATM (automatic teller machine), the balance requirements, transfers etc will all go up.
Number two, I have an option saying that I will just take a 30-day fixed deposit rather than the
savings account. There is no free lunch for the banks but there is no free lunch for you as well
as the market and forces have to be realistic. On behalf of the banking industry, I would like to
say that we are always for a fair deal for the customer. We are not against savings rate
deregulation. Deregulation has to be under normal circumstances. If you do it under tight
liquidity, that’s what we are all saying is an issue. We want a clear understanding that if you
deregulate then you will have to deregulate charges as well.
Q: You would say don’t do a savings rate deregulation unless the inter-bank rate is
operating at the reverse repo window?
A: That’s one way of putting it. I am just saying don’t do it in an atmosphere of scarcity. If it is
done in an atmosphere of scarcity, it could always be Rs400bn. A 1% net demand and time
liabilities shortage could always be there, that is steady state.
Q: But you won’t get more balances in the savings account.
A: What you will also do is, you will make saving accounts volatile for the banks, among the
system and you will completely stop any term lending by banks.
Q: Term lending would stop?
A: Naturally. If I don’t want an asset liability mismatch and I can’t prove that savings have got
stability with me, then it will have to be classified in the overnight bucket.
Mr O P Bhatt, Chairman, SBI
Within the savings bank product, there could be a range of sub-products offering different
facilities to the customer depending upon what kind of business they have with the bank. So,
while it would be very good for the customer, for the bank it would be challenging to retain
their share of CASA. (Source: Moneycontrol)
Ms Shikha Sharma, MD and CEO, Axis Bank
Deregulation is unlikely to impact margins in a big way. It will give greater flexibility in product
design. The savings account is the operating account for the customer and to the extent that
the customer is interest sensitive on what he does with the deposits, the seven day deposit
allows him to reflect that any way today. The seven day deposit is a deregulated rate.
(Source: Moneycontrol)
Mr Rana Kapoor, MD, Yes Bank (YES IN, CMP Rs273, Unrated)
Deregulating savings rates will benefit the consumer most of all. After the recent change in
moving towards a daily interest rate computation, the consumer is effectively gaining 1%.
From an average cost of 2.5% on a savings account, the banks are now paying 3.5% and its
sticky, stable money and long-term money. Banks should be permitted to actually free up
these rates and offer more market based savings rate. (Source: Moneycontrol)
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