RBI signals banks to raise deposit rates

On the heels of the provident fund board hiking interest rates by a percentage point to 9.5 per cent, the RBI today signalled to banks to raise fixed deposit rates to compensate small savers for rising inflation.

The move would also help banks garner more funds to meet their lending needs.

"If bank credit is not to become a constraint to growth, the real rates need to move in the direction of encouraging bank deposits", the RBI said while raising the key policy rates by up to 50 basis points for the fifth time this year.

While inflation was 8.5 per cent in August, the maximum return that banks are giving is 7.75 per cent on fixed deposits between three to 10 years.

The Central Board of Trustees, the highest policy making body of the Employees Provident Fund Organisation, on Wedday decided to raise the interest rate on provident fund deposits for 2010-11 to 9.5 per cent from 8.5 per cent. The rate is the highest in the last five years.

Some bankers have expressed the possibility of diversion of deposits to the provident fund on account of the increase in difference between the bank fixed deposit and PF rates.

About a year ago when the FD rates were about 10 per cent and the PF rate was 8.5 per cent, unions demanded that the two be aligned.

The RBI also said that the decision to raise short-term lending (repo) and borrowing (reverse repo) rates by 25 basis points and 50 basis points to 6 and 5 per cent, respectively, was "motivated by the need to end the prevalence of negative real interest rates".

Negative real interest rates refer to the difference between the deposit rates and inflation. It indicates that the bank deposits have not been adequately protected against declining value of money on account of inflation.

Bankers, including Bank of Maharashtra CMD Allen Pereira, Bank of Baroda Executive director R K Bakshi and Punjab and Sind Bank executive director P K Anand, opined that lenders would have to take a call on hiking interest rates in October.

In July, when RBI raised repo and reverse repo rate, 40 banks raised their deposit rates and 26 lending rates.

Currently, market leader State Bank of India pays 7.75 per cent on fixed deposit for 8 to 10 years, while the largest private sector bank ICICI gives similar returns on deposits with maturity period of three to 10 years.