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Tuesday, August 13, 2013

All about Savings Bank interest rates!

Every individual has a Savings Bank account, but pays little attention to the interest earned on the balance in this account. Some people may not even know that the balance they maintain in their savings bank accounts earn an interest. In the past, before RBI had deregulated the savings bank interest rate regime, all banks were offering the same interest rate, which was 4% per annum. When RBI brought about changes in 2011, banks became free to decide the interest rate they wanted to pay on their savings bank accounts, depending on their liquidity and profitability preferences.

How is savings bank interest ratescalculated?

Previously, the interest rate of 4% per annum was applied against the lowest balance available in the account between the 10th and the final day of the month. This was seen as a very unfriendly method of calculation, as the depositor did not receive full benefits of the amount he maintains in his account. From April 2010 onwards, this changed and the savings bank interest is now calculated based on the daily balance method. This means that you will earn interest based on the closing balance you maintain every day, giving you the maximum benefits. For example, let's say that your bank pays you an interest rate of 5% on your savings bank account. You have the following transactions during the month:

1st of the month: Balance in the account is Rs 3 lakhs

21st of the month: Withdraw Rs. 1 lakh ' Balance in the account is Rs 2 lakhs

25th of the month: Deposit Rs. 2 lakhs ' Balance in the account is Rs 4 lakhs

31st of the month: Balance in the account is Rs 4 lakhs

Your savings bank interest amount will be calculated at 5% on Rs 3 lakhs for 20 days, Rs 2 lakhs for 4 days, and Rs 4 lakhs for 7 days, instead of the earlier method wherein the interest is calculated on the minimum balance of Rs 2 lakhs. Thus, you stand to earn more in the present times than what you might have earned in the past.

What has the de-regulated Savings Bank interest rate regime resulted in?

De-regulating savings bank interest rates have definitely helped the customer to earn more interest, as competition for low cost savings bank accounts has led some banks to increase the interest rate offered. However, on the ground level, it is seen that not many banks have actually increased their rates beyond the 4% mark. For deposits below Rs 1 lakh, IndusInd BankBSE -0.53 %Kotak Mahindra BankBSE -0.33 % and Yes Bank offer higher rates at 5.5%, 5.5% and 6% per annum respectively, while for deposits above Rs 1 lakh, these banks offer 6%, 6% and 7% per annum respectively in that order. However, majority of the banks, including the big banks like SBI, ICICI BankBSE -1.02 % and HDFC Bank have retained the savings bank rates at 4% per annum. This shows that savings bank interest rate may not be the sole determining factor of which bank you must hold your savings account with; other reasons like quality of service, familiarity with the bank, user-friendly interfaces etc. also play an important role. In the case of HDFC Bank, their low cost deposits as a proportion to total deposits are very high at 45%, giving it less incentive to offer high interest rates.

The increase in rates on Savings Bank accounts also results in higher interest rates on short term deposits offered by the banks. An increase in deposit rates will lead to a contraction in the net interest margins of the banks. As a result, to maintain margins, such banks will increase their lending rates, leading to costlier loans. Although an increase in lending rates is a factor of many conditions, increase in the interest of low cost deposits is an important factor.

The high rates on Savings Bank accounts quoted by a few banks can go down if the rates on fixed deposits also go down and if the general interest rate scenario is soft. As the threat of inflation continues and RBI has still not shown signs of reducing rates, the current scenario is expected to continue for some time.

Taxation of Savings Bank Interest rates:

Unlike interest on fixed deposits, interest earned on savings bank accounts is not subject to Tax Deduction at Source. However, this does not mean the interest earned on Savings accounts is completely tax free. It is exempt upto Rs. 10,000 in a year, and if the interest you earn from Savings accounts crosses this threshold, it becomes subject to tax.

Things to look out for before you shift your Savings Bank accounts based on the interest rate:

As mentioned earlier, only a few banks offer high interest rates. However, you need to consider a few factors before you jump to shift your account. Ascertain the minimum balance to be maintained and the account closing fees. Sometimes minimum balance can be waived off if a fixed deposit is opened with the bank. Also evaluate the service charges and various ancillary fees. After all, your Savings account should offer you a host of benefits, rather than simply earning you interest.

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