Why Are Banks Cutting Savings Account Interest Rates for Lower Balance Accounts?

When the Reserve Bank of India (RBI) cuts interest rates, banks can borrow funds at a cheaper rate from the RBI. Consequently, they reduce the interest rates they offer to depositors as well as the rates they lend at. This trend is particularly noticeable in savings accounts. As banks try to maintain profitability, they adjust interest rates accordingly. This article explores the reasons behind reducing savings account interest rates and the role of the RBI in this process.

Role of the Reserve Bank of India (RBI)

The RBI plays a critical role in regulating the banking sector in India. Whenever the central bank cuts interest rates, it means that banks are earning lower interest from customers. When the bank’s earnings from loans are lower, it will subsequently pay lower interest to depositors. Hence, the decision to reduce savings account interest rates is directly influenced by the RBI's actions.

Money as a Product

Money can be considered a product whose price fluctuates based on supply and demand. Post demonetization, banks are loaded with money but unfortunately, the demand for productive usage is low. Additionally, loan regulations are stringent, making banks cautious about extending credit. This context drives the overall trend of reducing interest rates, both domestically and internationally.

Banks' Role in Maintaining Interest Rates

Banks borrow and lend at different interest rates to cover their operating costs. Deposits that banks take range from 14 days to 5 years, while loans have an average tenure of 7 years. Due to the mismatch in duration, banks prefer longer-term deposits to avoid liquidity issues. Fixed Deposits (FDs) offer higher interest rates because the money is locked in for a longer period, ensuring liquidity stability. In contrast, savings accounts require a certain level of liquid funds, which the bank can invest at lower interest rates.

Encouraging Higher Balance Maintenance

Lower interest rates for savings accounts are a strategic move by banks to encourage higher balance maintenance. By offering additional benefits for maintaining higher minimum balances, banks aim to secure more stable and longer-term deposits. HNIs (High Net Worth Individuals) are not the only ones who benefit from these incentives; every customer can enjoy better terms by maintaining higher balances.

Financial Inclusion and Interest Rates

Financial inclusion is a critical goal, but it does not mean simply encouraging people to deposit their savings. Many people prefer to keep their money in cash due to potential liquidity needs or unpredictable income streams. Offering exorbitant interest rates on low balances is not practical; instead, banks should focus on providing no-frills accounts that offer minimal but stable interest. The real challenge lies in helping the unbanked and underbanked population access affordable loans at reasonable interest rates.

Conclusion

Reducing savings account interest rates for lower balance accounts is a rational business decision aimed at maintaining profitability and encouraging better liquidity management. Banks cannot afford to offer high interest rates to all account holders, especially those with low balances. The key is to balance profitability with the needs of both the bank and its customers, including those who are financially excluded. By doing so, banks can promote financial inclusion and provide better financial services to a wider audience.