Interest on Deposits – Moving Towards Computing Standards

Abstract

The Reserve Bank of India (RBI) on March 3, 2016 came out with master directions on ‘interest rate on deposits’. These directions over rule all the existing instructions on the subject and applies to all deposits accepted by banks based on the rules prescribed hitherto. In the master directions, for savings deposits, RBI has mandated that banks pay interest at quarterly or shorter intervals. Savings Bank (SB) deposits and Term deposits amount to more than Rs 90 lakh crore at present. In the absence of any regulation on interest application frequency to such deposits, till now most of the banks were paying interest on the SB deposits, that accounts for more than a quarter of the total deposit pie, at an interval of six months. Under the prevailing SB interest of 4% per annum, the new regulation would benefit the SB depositors to the tune of Rs 500 crore or more from the next financial year.

Though this is a major step in favour of the depositors, a disparity compared to loans is still left unattended. For loans taken from the banks, the interest is computed at monthly rests. In other words, if a borrower defers payment of interest by two months, the banks charge two months’ interest on the delayed interest. Though RBI has deregulated rates of interest on Term deposits, SB deposits and loan accounts, it still regulates the interest application frequency on such products, disharmoniously. The regulator provides no rationale on why interest application frequencies on deposit accounts (quarterly or shorter intervals) are different from those for loan accounts (monthly intervals), both of which are to the benefit of the banks and detrimental to the interest of the borrowers and, even more so, depositors. RBI has a responsibility to bring in standards and transparency in interest application frequency, in the interests of the depositors.

RBI has also left to the banks the method that they may adopt for computing interest. Absence of regulation gives banks the freedom to decide, in a non-transparent fashion, the effective annualised returns on deposits held by them. With this, the depositors are burdened with the problem of shopping among banks for the most attractive methodology used in their interest application and computation procedures. The depositor is neither capable to make such comparisons nor aware that such matters affect his return. And depositors’ ignorance is a big asset for banks. In the annual monetary and credit policy for the year 2002-2003, there was a proposal that banks should provide information on deposit interest rates for various maturities along with the effective annualised yield. However, RBI neither came up with any formal directions to implement the proposal nor explained how absence of accounting standards will help the real stake holders, that is, the depositors.

Unlike some of the global best practices, lack of basic accounting standards in India gives administrative convenience to banks and the regulator and thrusts responsibilities to the depositors to read between the lines. Is it not too unrealistic for the regulator to expect (i) the depositors to ask the banks to show their method of computing interest, (ii) the banks to have a comprehensive and easy to understand document for the same, and finally, (iii) the depositors to understand the method and then have the ability to compare banks? It needs to be appreciated that this is too much of expectation from depositors since there are ground level limitations.

While trying to ensure that the depositors’ earnings are derived in a transparent and comprehensible manner using prudent accounting/computing standards, through this paper we attempt to reiterate the need to address the skew in the present interest computation setup that is disadvantage to the depositors. Some recommendations are made to address the concerns.