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India: Deposit rate liberalization stirs competition

Smaller banks lure new custom; Sluggish big banks likely losers

India’s uncompetitive, backward banking industry has received the mother of all shake-ups, thanks to the central bank’s decision to deregulate interest rates on savings accounts.

Reserve Bank of India (RBI) governor Duvvuri Subbarao chose the Diwali holiday period – typically a time when Indians spend heavily – to promote the concept of hoarding cash, with Subbarao pledging that banks operating in India, whether foreign or local, would be immediately "free to determine their savings bank deposit interest rate" for the first time in 34 years.

Analysts mostly hailed the move, which will create winners and losers within a banking market widely viewed from outside as a cosy, collusive cartel.


Beneficiaries are likely to be a welter of smaller, newish and privately run local lenders such as Axis Bank and IndusInd Bank, along with a smattering of well-run state lenders led by Union Bank of India.

Yes Bank, founded in 2003, boasting 300 branches, and one of the lenders likely to benefit most from the RBI’s decision, immediately raised its savings rate to 6%, a move designed to generate new business, as well as headlines. Yes Bank founder-chief executive Rana Kapoor heralded the move, claiming that it would boost competition and draw a line under what he described as an era of "lazy banking".

Universal banks such as Citi, HSBC and Standard Chartered should benefit too, as customers drift toward efficiently run global lenders with broad local presence and high levels of service.

"Other beneficiaries are likely to be customers and the central bank, as after deregulation any rate hikes by the RBI will be transmitted to the economy in a more efficient way, while customers can earn higher deposit rates"

William Mak, Nomura

William Mak, an analyst at Nomura in Hong Kong


"Other beneficiaries," notes William Mak, an analyst at Nomura in Hong Kong, "are likely to be customers and the central bank, as after deregulation any rate hikes by the RBI will be transmitted to the economy in a more efficient way, while customers can earn higher deposit rates." Slothful state banks and bulkier private lenders more dependent on savings deposits are likely to miss out. Paresh Jain, an analyst at Karvy Stock Broking, highlights State Bank of India and ICICI Bank as the more prominent losers.

CLSA analyst Aashish Agarwal notes that the only viable tactic for these larger Indian lenders (who dismissed the decision as meaningless and refused to raise their own savings rates) is to create a "prisoner’s dilemma" scenario, where all larger banks "act in their collective interests". In other words: they will seek to perpetuate an increasingly fragile cartel within an increasingly liberal financial environment.

The market has taken note, with ICICI’s stock declining and Yes Bank securities ticking up 9% following the announcement.

Shot in the arm

There’s little doubt that India’s local retail banking industry, one of Asia’s most lethargic and poorly developed, needs this shot in the arm. Critics say fixed rates (the savings rate remained stuck at 3.5% for eight years until May 2011, before inching up to 4%), merely fostered an ambivalent, sluggish, self-satisfied clique of banks allergic to competition, service, and new technology.

Under the new rules, announced at the end of the central bank’s quarterly monetary policy review, lenders are permitted to offer varying rates of interest on deposits of more than Rs100,000 ($2,025), although deposits below that level will remain fixed.

India’s financial scene should benefit in other, less immediately tangible ways. Indians, despite being reasonably strong savers, usher more of their capital than average into physical savings such as gold, diamonds and jewellery.

Savings siphon

A more competitive banking landscape, focused on better lenders offering higher interest rates (vital in a country beset by stubbornly high inflation) should now siphon more savings into the financial services sector. It might also encourage non-resident Indians living abroad and faced with savings rates at or below 1% in the developed world, to channel cash back into the motherland in search of higher returns.

New banks entering the fray will also benefit. The RBI is widely expected to issue around a half-dozen new retail banking licences by the end of this year or in early 2012, in an attempt to expand financial services competition to customers in lower-tier cities and the rural hinterland.

Names such as investment bank Edelweiss, Shriram Transport Finance, and Mahindra Finance, and Infrastructure Development Finance Company, are in the mix.

All, if issued with a precious new licence, would benefit from a banking sector that encourages customers to trust their money to banks offering fresh ways of thinking in a sector undergoing reforms that some have waited for since 1977, when Indira Gandhi, the country’s hardline socialist premier, was in power.

Better late than never.

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