You may not always know the means behind a magic trick unless someone enlightens you with its secrets. Similarly, understanding why different banks react differently to RBI’s rate cuts is equally illusionary, and here we help you break the bubble and get some upfront clarity on it.
The significance of cost
You may notice that while some banks cut the deposit rates or lending rates, some tend to cut both. This happens because in both cases, it all depends on the bank’s overall funding. You may be aware that banks borrow money from their depositors and then lend the same to their borrowers at a much higher rate of interest. The difference between these two rates is termed as the Net Interest Spread; and the higher the spread, the better it gets for the bank.
A bank’s borrowing cost is inclusive of the average rate of deposits such as fixed deposits, current account deposits and savings account deposits. While banks pay more interests on fixed deposits, the interests tend to get lowered in case of current account and savings account deposits. In the Indian context, the money deposited in current accounts earns no interests, whereas if you have a savings account, you can earn a savings account interest rate of up to 5% on an average. On the other hand, FDs with one year or more maturity period earns an interest rate of up to 8%.
So, if a bank has a higher current account and savings account deposits, the overall cost of funding for the bank becomes lower than a bank whose current account and savings deposits are lesser in number.
The Current Account and Savings Account Ratio
The proportion of current account and savings account deposits are termed as CASA deposits. The higher the CASA ratio, funding for the bank becomes even lower. It also means that the bank has lesser chances of reducing the deposit rates as and when RBI cuts interest rates.
Net Interest Margin
The CASA ratio plays an integral part in determining whether a bank would change its interest rates in the future or not. A more advanced indicator of the same is the Net Interest Margin (NIM) of the bank. This type of interest is the bank’s overall interest earning assets during a year. It is calculated by dividing the difference between the interests paid by the bank’s total interest earning assets and the total interest earned by the bank. It basically shows how profitable the bank’s operation has been for a specified amount of time. The higher the NIM, the lesser are the chances of a bank to reduce the deposit rates in future.
So, the next time you are stuck in a dilemma about continuing your savings account, current account, or fixed account deposits in a particular bank due to a slash of deposit rates, reconsider the above mentioned scenarios. You must also take note that banks sometimes tend to change lending or deposit rates due to a rising competitive market.