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Saving accounts to become more lucrative

By Arnav Pandya in Mumbai
May 04, 2009 11:51 IST
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The calculation of interest payouts on savings accounts has always been a contentious issue. Account holders have found that, in spite of having a high amount of cash in a savings account for a better part of the month, the interest paid to them is low.

The reason: Calculations are done by taking into account only the lowest amount present in the last 20 days of the month.

No wonder, most people do not pay any attention to the calculation of the savings bank interest because of the small amounts of returns, though tax authorities take them into consideration while calculating the liability.

However, the Reserve Bank of India has taken note of this discrepancy in the calculation of savings account interest rates. Thanks to the RBI, this calculation will completely change from April 2010.

With the new system, it will become even more important to keep track of the earnings because the amounts will be higher.

Before understanding the new system, let's look at the way the old system worked.

Typically, a savings bank account is one where a person deposits his/her salary. And working capital requirements, like monthly expenses, are carried out from that account. As a result, there is a constant fluctuation in cash levels in this account.

The only restriction in these accounts is that that some banks look for a quarterly balance of Rs 5,000 or more. And, given the few restrictions, the interest paid on the balance is also the lowest at 3-3.5 per cent a year.

However, the bone of contention is not the low rate of interest, but the way the interest is paid on these accounts. At present, though the interest calculation is done on a monthly basis, the account holder is paid the amount either at the end of three or six months.

What is, however, more contentious is the balance that is considered while paying the interest. That is, banks consider the lowest amount in the account between the tenth and the end of any month. And the interest is paid on that amount.

Let's consider you have a balance of Rs 1 lakh (Rs 100,000) at the beginning of a month and it increases to Rs 1.5 lakh (Rs 150,000) by the 15th. But, due to investment commitments and other expenses, the amount on the 28th of the same month becomes Rs 50,000.

The bank will pay interest on this Rs 50,000. The larger amounts held during the entire month will not be taken into consideration at all (see table).

Opening balance (1st) = Rs 32,000
Deposit on 15th = Rs 25,000
New Balance = Rs 57,000
Interest payment (old method) = Rs 93
(3.5 per cent of Rs 32,000)
Interest payment (new method) = Rs 132

Opening balance (1st) = Rs 90,000
Cheque cleared on 30th
(last day of the month) = Rs 50,000
Remaining balance on 30th
(last day of the month) = Rs 40,000
Interest payout (old method) = Rs 117
(3.5 per cent of Rs 40,000)
Interest payout (new method) = Rs 257

And these calculations are done on a monthly basis. Since the present conditions allowed banks to pay on the minimum balance, it was easy to implement.

In terms of behaviour, this means several things.

When it comes to the question of deposits of amounts in the accounts, only those ones that have been deposited before the 10th of the month will be used for the purpose of the interest calculation.

After this, the minimum balance criterion kicks-in. So, any deposit after this period is not used for calculation.

Also, when it comes to issuance of cheques or equated monthly payments of loans, all outflows after the 10th of the month will only lower the existing balance.

This is actually the area where a lot of people take a big hit. If you have a savings bank account with a balance of Rs 12,000 on April 1, and then deposit Rs 5,000 on April 5, while withdrawing Rs 10,000 on April 15, the balance will be Rs 7,000. A further deposit of Rs 30,000 on April 25 will bring the balance to Rs 37,000.

In the case of the existing calculation for interest on savings accounts, the balance for the interest in the above example will be Rs 7,000, resulting in an interest of Rs 20. This shows how the withdrawal is considered, but not the cheque deposit.

Under the new calculation, the interest on the savings bank will be calculated on a daily balance method. This will mean that the individual will get the benefit of a higher base for the investment calculation, in case the amount has been lying in the account for a longer period of time.

For instance, if we consider the same example above, the account holder will be paid higher interest because of the Rs 37,000 balance for five days.

This is similar to the situation of loans where a daily reduction of balance allows a person to pay lower interest rate. On the other hand, monthly or quarterly rest (read reduction of balance) means a much higher interest payout.

By making the system same for loans and deposits, the apex bank proposes to ensure that there will be uniformity in the way interest rates are calculated for both transactions.

This will also mean that keeping money in bank accounts will become more lucrative. 

The writer is a certified financial planner.

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Arnav Pandya in Mumbai
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