Global ratings agency Moody's on Monday said that RBI's recent move to deregulate savings interest rates will reduce banks' profitability.
"Banks are now free to set their own interest rates ... a direct consequence of this policy is that banks can, and will, offer higher interest rates to compete for savings deposits, thereby, undermining the role these deposits play as a relatively stable and low-cost funding source. We expect the move to exacerbate already increasing pressure on net interest margins and asset quality," Moody's said in its 'Weekly Credit Outlook'.
In a major policy decision announced during its second quarterly monetary policy review last week, the Reserve Bank deregulated saving bank deposits rates.
The step is expected to fetch better returns for depositors as competition will intensify. Moody's said the step to deregulate savings bank deposit rates, along with the hike of 25 basis points in its key policy rates announced during the review will 'hurt banks' profitability and thus, are credit negative.
"Savings deposits now account for almost a quarter of the system deposits. For decades, RBI has been setting interest rates on savings accounts and, starting last May and right up until this move, the rate was 4 per cent," it said.
On the other hand, time deposits generally carry much higher nominal interest rates of 8.5-9.5 per cent.
"Amid the current inflation of nearly 10 per cent, this implies that savers have substantial negative real return on their savings
deposits... We expect public-sector banks to be the ones most negatively affected by this development," Moody's said.
It further said that with the deregulation, public sector banks will need to pay significantly higher interest to maintain their deposit base, notwithstanding their distribution advantage in the rural areas.
"Conversely, private banks, which are perceived to offer superior customer service and more advanced information technology, will use this pricing freedom as a new tool to gain market share. This is especially true for the newer and smaller players that are especially keen to develop stable funding bases," Moody's said.
Following the RBI's announcement, Yes Bank and Kotak Bank had raised interest rates on savings deposits in their banks up to 6 per cent.
Today, another private sector lender IndusInd Bank also hiked interest rates on savings accounts by up to 200 basis points, offering clients a return of 6 per cent on their deposits.
"Competitive pressure also makes it unlikely that the banking sector (including private and public banks) will be able to pass on the entire increase in funding costs to borrowers, implying narrowing interest margins ahead.
"And, to the extent that banks do raise lending rates to mitigate their increased funding costs, borrowers' debt-servicing capability and banks' asset quality will be undermined," Moody's said.
The rating agency added that the move was unlikely to help insurance firms, too.
"Bank deposits, which offer higher interest rates and greater liquidity, are apt to lure some customers away from buying savings-type insurance products," it said.