Quarterly interest means depositors lose Rs 2500 crore per year - Interesting Article

Source: Economic Times

Depositors are losing close to Rs 2,500 crore every year because of Indian banks applying interest on deposits every quarter instead of every month, according to a report by the Indian Institute of Technology, Mumbai. This is in contrast to loans where interest is applied on a monthly basis.

To study the impact of this discrimination, one needs to compare the interest liability on a Rs 1 lakh education loan at the end of the year compared to earnings from a fixed deposit assuming interest on both was 10%. While the interest earned on the FD would be around Rs 10,381, the interest liability on the loan would be Rs 10,471. Such comparison is only possible in education loans where there is no repayment in the first year.

At present, the Reserve Bank of India (RBI) mandates banks to apply interest on deposits at quarterly or larger intervals. Banks also calculate interests accrued on a fortnightly basis but only for reporting to RBI.

The technical report by Ashish Das from IIT's mathematics department published this week is expected to be taken seriously by RBI, considering that the central bank itself had raised the issue in the past. The report, titled 'Interest of bank depositors in chaos', has studied interest application frequency on bank deposits and the methodology used by banks in calculating interest income.

The regulator also paid heed to earlier reports from the same author, which resulted in regulatory changes including recommendation that banks apply interest on daily balances in savings deposits. A subsequent paper had suggested that RBI directs banks to reduce fees charged to merchants for settling payments from debit cards since banks were merely transferring funds from customer accounts and not providing a loan to the cardholder as was happening in credit cards.

"The application of interest at six monthly rests has been more of a legacy. It was more from the ease and convenience of interest computation at the pre-computer era. Such a scenario no longer exists since the country today has a satisfactory level of computerization in commercial banks," said Das. The report points out that because of lax regulation some banks such as HDFC Bank (effective April 2011) moved from their earlier quarterly application of interest to half yearly application. "Such a move, though beneficial to the banks, is at the cost of their SB depositors," the report said.

If banks were directed to apply interest at the end of every month, the return for the depositor would rise by a around Rs 90 for someone with a Rs 1 lakh FD.

At a systemic level, total savings to banks runs into crores considering that there are 800 million bank accounts with Rs 15.5 lakh crore in savings accounts and Rs 45 lakh crore in FDs.

The study also finds that the amount of tax deducted at source can come down by Rs 400 to Rs 500 crore if banks applied TDS at the end of the financial year and paid the amount out of savings account rather than charging it to the fixed deposit.