The Reserve Bank of India (RBI) has made another dangerous move by freeing up the interest rates on savings accounts deposits. In an earlier argument against this, I had said that RBI should have, in fact, made this ‘zero’. Now, RBI has ensured a cut-throat race amongst banks, to fight for savings accounts deposits. This is great for the individual who keeps his money in a savings bank account. Unlike in the past, we must now ‘shop’ with banks for higher and higher rates. Yes, RBI has said that for identical amounts, banks cannot differentiate in the interest rate offered. That does not mean that we cannot get freebies from a bank. We should club our accounts together and use it as a bargaining tool. In case banks refuse higher interest rates, we can always bargain for some other freebie. Now, we will also have to be more combative and watchful with banks. They will try to make up for the higher interest rate by imposing a charge for virtually everything—from the number of cheque leaves to imposing a charge on a visit to the branch for anything. Perhaps, they will also start delaying clearance of credits to enjoy a ‘free float’ on our money. While it looks good for the depositor, what about the banks? Not very good, I think. They will perhaps put up a brave front and say that they will hike their lending rates also. But wait. Why would any blue-chip corporate borrow at usurious rates? Maybe they can borrow elsewhere. This would force banks to extend credit at high rates to riskier customers. Generally, when interest rates are high (both ways) the net spread a bank makes is higher than when interest rates are in single digits. So, initially, it would seem as though banks would make higher profits. However, my call is that banks will be in a rat race to mop up deposits and end up paying high costs. Lending will deteriorate in quality as banks will seek to deploy the high-cost funds and earn a spread on it. What is the implication for investors? I would keep away from bank stocks for some more time, until RBI gets its act together on inflation. After all, after 13 continuous upward nudges of interest, inflation still remains high. A large portion of savings bank and current account deposits (CASA, as it is popularly known) gives some banks an edge. For instance, State Bank of India (SBI) and HDFC Bank have CASA deposits that constitute nearly 48% of their total deposits. Now, the interest costs for these two banks will rise much higher than those for banks that have a lower proportion of CASA. What will be interesting is to see what happens if, and when, liquidity in the domestic market eases. Today, tight liquidity has pushed up short-term borrowing and lending rates so high, that there is not much gap between interest rates on a 30-day loan and a 10-year loan! Liquid funds give returns almost in line with yields on 10-year government securities! Once liquidity eases, will the returns on liquid funds crash? Logically, they should. Then, we will have the funny situation of savings accounts returns beating liquid fund returns! And, with banks being forced to pay interest on ‘daily’ balances, savings accounts should replace liquid funds, for the individual investor. We need not go to liquid funds at all. It saves us the bother of filling forms for purchase and redemptions. Another implication is that interest rates are going to play an important role in all financial advice. We are perhaps entering a phase where fixed returns are going to be more tempting than equity returns, as companies struggle to grow in the face of weak capital markets, flagging demand and high resource costs, combined with runaway wage costs. RBI has set in motion a run-up in interest rates that will benefit the saver in the short term. I only hope that the lending rates do not go so high that they kill borrowing, and borrowers.
Moneylife
