This is an article published in November when RBI deregulated the savings bank rate in India. This piece looked at the implications of this move, beyond increase in cost of borrowing as was being touted by all analysts.
RBI’s saving rate deregulation move has the potential to change the competition leader board across various product categories. Rather than viewing this as a run of the mill cost of funds increase issue banks need to take a holistic view of their entire product portfolio vis-a-vis competition in light of this change.
Savings accounts with their lower interest outflows have provided large banks with a rate cushion to price their lending products more competitively than their savings account poorer banks. But all this is about to change and how. What was till now a relatively passively consumed and marketed product has the potential to become an extremely actively competed for product. And the timing and scale of the competition this time will not be decided only by the larger banks. If the smaller banks play their cards well and aggressively, they will be able to pull in the larger banks into the competition to the smaller bank’s benefit.
Some banks have been quick to jump onto this bandwagon and have already raised their savings rates while other are playing the wait and watch game. Yes Bank raised its savings rate by 200 basis points within hours of the RBI move. Kotak and Indus Ind followed suit a couple of days later. The larger banks have clearly stated that they will adopt a wait and watch policy and respond only if the situation demands it. We have also seen most brokerage houses giving their views on this and most have been dead right in their calculations of the impact on the NIMs of various banks. But what has been missed is the opportunity this deregulation would provide to various banks to improve their lending business and the resultant NIM increase from there.
There are three most probable scenarios at each bank post this:
Scenario 1 – Savings deposits reduce (as a percentage of total deposits) and are replaced by higher cost term deposits (This is when customers are weaned away to other banks)
Scenario 2 – Savings deposits remain the same but now cost higher (This is when banks need to increase rates just to maintain status quo)
Scenario 3 – Savings deposits increase and term deposits reduce (This will happen under two conditions – a) With the differential between them now lower some customers may be more willing to forego slightly higher interest for liquidity. This is a desirable scenario and banks need to use data analytics to identify their customers most likely to fit this profile. b) This will also happen because new customers would be acquired from lower interest paying banks. Though interest rate is not the only criteria while customers choose a savings bank, there will still be customers, more so the higher balance customers who could be enticed.)
Banks would therefore do well to take a holistic view of these scenarios not only for themselves but for their competition too, as scenario building in the true sense always encompasses the competition landscape. There are a couple of scenario building and war room planning tools available which banks could use.
Below we see a sample scenario model, which demonstrates the use of scenario building for ‘Cost of deposit’. We have used Cost of deposit as a proxy for Cost of funds. We have used two banks here to build scenarios – the larger bank being the defender and the smaller bank being the challenger. The contribution column shows the percentage composition of each type of deposit to the total. (Average term deposit rates have been assumed at 9%. From a
cost of deposit perspective demand deposits have zero direct cost, though they have a higher intermediation cost, which is not accounted in cost of deposit)
These scenarios have been built with certain assumptions primary amongst those being that quite a few banks will come forward and increase their savings rates across the board. This has actually already taken place.
Originally there was a 122 basis point difference in the cost of deposits between the two banks. In the first scenario where the defender loses savings deposits and the challenger improves its savings contribution, we see the difference in COD being whittled down to 57 basis points. The point to note here is that the COD improved for the Challenger bank by only 23 basis points but its competitiveness on COD against the Defender improved by 65 basis points. A 50 basis points gap is a competitive advantage in many keenly fought consumer lending products!
Similarly in the second scenario even though the Challenger bank’s COD increased by 17 basis points, its competitiveness against the Defender improved by 28 basis points. This is classic Sun-Tzu!
What this whittling down of the COD gap does is that in certain highly rate sensitive products (from the customer’s point of view) the Challenger bank can now think of mounting a serious challenge. Earlier the Challenger may have been lying low as the gap of 1.22% was too large to make up in rate sensitive products (like in housing loans, car loans), but now is in a better position to mount a challenge. The Challenger may now revisit its entire customer proposition as it is no longer fighting in the market from a position of lending rate weakness. Challenger banks which thrived on catering to a slightly riskier customer profile in the race to get a higher yield will now use that risk expertise to move into the hitherto prime customer space occupied by the large banks.
At a tactical level increase in business will come from reaching out to the right channels and clients. Business verticals with rate sensitive customers should be involved in this scenario planning exercise to understand the role which each vertical will play. Business verticals should also have their plans ready for the different played out scenarios. Each vertical will need to list their competitors and their prevalent lending rates and basis the different probable scenarios, their competitors’ probable lending rates by product. Basis inputs from all a grid mapping competitors and products with the new rates for all customer rate sensitive products should be drawn out. This grid should be used to target the distribution channels and clients of competitors who now seem weaker or within striking distance. The challengers need to have their plans in place before the events occur to be the first to take advantage of the changes in the market place. Similarly the Defender banks will be able to identify the potential challengers across their product suite and be able to build defences accordingly in advance.
One of the powerful tools used in such scenario building exercise is an Advanced Solution Centre, a proprietary tool of Ernst and Young.
This exercise is played out in an event based setup over 2-3 days. The spade work is done prior to the event by collating all possible data that will be required during the event. The participants in the event are not just the senior management but also a sprinkling of the ground forces to bring a more ground level feel to the exercise. During the event the participants are exposed to various tools including rich pictures, thinkshop, metaphors and stories. The participant groups are assisted in formulating scenarios and in repeatedly defending them. This helps create a list of possible scenarios with robust response plans.
Scenario building is a powerful tool and the savings rate deregulation offers a good opportunity to the Indian banks to embrace it like their global counterparts. We are heading into exciting times for the market.