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Multiple

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July 9, 2022

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14

min read

A colleague recently asked me this question as I sat with a cup of coffee during my coffee break at work — *How much interest do you earn on your savings account?*

Despite its obvious simplicity, this little query had me confused at first. Savings banks aren’t like fixed deposits. They don’t pay you any interest, right?

Wrong. So wrong.

Prompted by this discovery, I went down the rabbit hole and found - to my dismay - that I had been banking the wrong way all these years. And as a result, I lost out on a ton of interest I could have otherwise earned.

To give you a bit of my backstory — I opened my first bank account at the age of 20, and for the past decade, it’s the only bank account I’ve had. Considering myself something of a loyalist, I was always proud of my banking situation. Until now.

Well, it’s never too late to right a wrong situation. But hey, why don’t I fill you in on everything I’ve learned about interest rates on savings accounts? That way, you don’t have to make the same mistakes I did.

Interest is the cost of borrowing money. So, the borrower pays interest to the lender. The best way to understand this is to take the case of a loan. When you avail a loan from a bank, you are free to repay it over a particular number of years in instalments. In return, you pay interest on the amount borrowed, right? That sums up what interest is.

But wait a minute. In the case of a savings account, *who *is borrowing money from *whom?*

Well, technically, when you open a savings account and put some money in there, the bank is kind of borrowing money from you. And in return, the bank pays you interest on your savings account balance.

The bottom line is this — You get to earn interest simply by saving money in your bank account. Cool right?

In the case of a fixed deposit, the interest calculator is quite easy to understand. You deposit a fixed sum at the beginning of the investment period, and that amount remains in your deposit account till the FD matures.

But a savings bank account is different. The balance in your SB account may fluctuate on a day-to-day basis. When your salary is credited at the beginning of the month, the balance increases. And then, when you withdraw some funds to pay your rent or buy groceries, your balance goes down. Later, you may receive payouts from your monthly investment plan, driving the SB account balance up again.

So, how do banks calculate interest on such a fluctuating balance? The answer is simple. Banks calculate your interest on your savings account balance on a daily basis.

But the interest is credited to your savings account on a quarterly basis, as per the RBI regulations. That said, banks are also free to credit the interest to your account on a monthly basis.[2] So, this policy will vary from one bank to another.

Simple interest is basically interest that is calculated only on the amount you have deposited. But compound interest is calculated on the deposited amount as well as the interest you earn on that deposit.

And the interest on your savings account balance is compounded. So, you get to earn interest on your interest!

For instance, let’s say your savings bank account with the following particulars —

- Rate of interest: 5% per annum
- Account balance: Rs. 1,00,000
- Interest credited: Monthly

In that case, assuming there are no deposits or withdrawals, here is how compound interest lets you earn exponentially.

See how you earn interest on interest, all thanks to compounding?

If you aren’t a total noob like I was, and if you have a fair bit of an idea about interest rates on savings accounts, you know that different banks give you interest at different rates. I did a little bit of digging, and I found that this wasn’t always the case. Back in the day, the Reserve Bank of India had the final say in deciding how much interest to pay on savings account balances.

And for a really long time, from 2003 up until 2010, all the banks in the country offered interest on savings accounts at the same rate - aka 3.5% per annum.[1]

But in 2011, the central bank deregulated savings bank interest rates. In other words, banks in India were now free to decide the rates of interest on their savings account. This policy has continued to this day, and Indian banks - both in the public and private sector - set their own savings account interest rates.

Ever since the interest rates were deregulated, most of the large, established commercial banks in India have maintained low rates of interest on their savings accounts. They only raised the rate marginally, from 3.5% before 2011 to around 4% or so. However, newer banks have been famous for offering higher interest rates on savings accounts, often in the range of 6% to 7% or so per annum.

So, all in all, the spectrum of savings account interest rates in the Indian banking sector can range from 3.5% to 7.8% or so today. Given such a vast difference, it is clear that there are many factors at play here. Check out the main parameters that banks take into account before determining how much interest to pay on savings account balances.

**Repo rates**

Repo rate is the rate at which the Reserve Bank of India lends money to commercial banks in the country. To put it more simply, it is the rate at which commercial Indian banks borrow money from the central bank. Every quarter, the RBI reviews the repo rate and depending on national and international economic factors, the rate may be increased or decreased.

If the repo rate increases, it makes borrowings costlier for commercial banks. To compensate for the rising cost of borrowing, these banks hike the interest rates they charge on the loans they lend.

But what about the interest rates on savings accounts? Well, the money deposited in savings accounts is valuable for banks because it helps them meet their minimum cash requirements without having to borrow money from the RBI.

In an economy with rising repo rates, banks will naturally try to draw in more people to deposit money in their savings accounts. And how do they do this? By increasing the interest rate on savings accounts, of course!

So, rising repo rates lead to rising savings account interest rates.

**Liquidity**

While the repo rate is the main factor that banks take into account before deciding the rate of interest on savings accounts, there are other aspects that play a role in this too. The liquidity of a bank is one such factor. It indicates the level of cash and other liquid assets that the bank has, so it can pay its short-term bills and financial obligations.

The more the liquidity, the higher the interest rates on savings accounts will be. The reason is simple. If the bank has enough liquidity to meet its short-term needs easily, it won’t have any trouble paying out higher interest on savings account balances. On the other hand, if there is some issue with the cash flow leading to poor liquidity, the bank may have trouble meeting this obligation. So, to protect its finances, the bank will reduce the interest rate on savings accounts and deposits.

**Profitability preferences**

While the repo rate and liquidity status are universal, profitability preferences are very specific to each bank. Some banks will want to enjoy a higher profit margin, while others may be willing to lower their profitability in order to increase their customer base.

Typically, established banks with a trusted customer base may tend to prioritise their profitability. They can afford to offer lower interest rates on savings accounts. On the other hand, younger banks who have only just arrived on the scene may put profitability on the back burner and focus on paying interest at higher rates, so they can attract more depositors.

Are savings account interest rates and FD interest rates the same? No.

Typically, in any given bank, the interest rates on savings account balances are lower than the interest rates on fixed deposits. The reason is simple. In a savings account, you are free to withdraw your money as and when you please. But an FD is less liquid. Your money is typically locked in for the entire investment tenure (although you can withdraw it by paying withdrawal charges).

So, since FDs are a more permanent source of funds for the bank, they pay you a higher interest on fixed deposits than on savings accounts. But remember that savings accounts, being more liquid, are better suited for you if you are planning to keep your funds more accessible. And anyway, the difference between most SB account rates and FD interest rates is quite marginal these days.

If you open an FD today at a 6% interest rate, that rate is locked in for the entire tenure of your investment. Even if the bank revises the FD rates to 6.25% the next quarter due to repo rate changes, you will continue to earn interest at just 6% on your FD account balance.

But a savings account comes with flexible interest rates that fluctuate based on the bank’s policies. This means if you open an SB account today at a 4% interest rate, you will continue earning interest at this rate on your savings account balance till the bank revises its policy. If the interest rate on savings accounts is revised to 4.5% per annum, your account balance will earn interest at this rate after the revision.

Ever since I had that short but enlightening discussion about savings account interest rates with my colleague during that 10-minute coffee break, I have been on a quest to figure out how to maximise the interest I earn on my savings. Here are my two cents in this regard.

**Look for high yield savings accounts**

The most obvious way to maximise your SB interest? Choose a bank that offers high interest rates on savings account balances. The higher the rate of interest, the more interest you will earn on your savings.

That said, the interest rate is not the only factor to account for when you are choosing a banking partner. You also need to consider the other fees and charges that your SB account comes with, the minimum balance requirement, and the bank’s customer service quality, in general.

**Deposit your idle cash**

No matter how much interest on savings account balances your bank is willing to pay, you will only earn money on the funds you deposit. The lower your account balance, the lower your interest will be.

For instance, a savings account with a 6% interest rate and a monthly balance of Rs. 10,000 will only give you an interest of Rs. 49.31 at the end of 30 days.

But a savings account with a 4% interest rate and a monthly balance of Rs. 1,00,000 will give you an interest of Rs. 328.76 at the end of the same period.

So, to maximise your savings account interest, don’t keep cash lying idle at home. Deposit it in your savings account instead. That way, your money is secure, *and *you get to earn interest on the amount deposited. That’s a win-win!

**Choose monthly interest credits if you can**

Banks are mandated to pay out the interest at least on a quarterly basis, but they can choose to pay it out each month if they wish to. Monthly interest credit allows you to earn more interest on your interest. Check out the table below to see how this works.

However, in case of quarterly interest credit, the balance in your SB account will remain at Rs. 1,00,000 for the whole three months (assuming you do not make any deposits or withdrawals during the period). The interest on that amount would be calculated as follows -

= (1,00,000 x 5% x 91 days) ÷ 365 days

= 1,246

This makes your balance at the end of the period just Rs. 1,01,246. It may be a small difference here, but over time, and depending on your account balance, the differences can add up.

Maximising the interest on your savings account is one thing. But paying taxes on that extra interest is another. And you *need *to pay taxes on the interest you earn from your SB account. The tax rate is the same as your income tax slab rate. So, if your income puts you in the 30% slab, that rate will also apply to your SB account interest.

Say hello to section 80TTA of the Income Tax Act, 1961. It allows you to claim deductions on your savings account interest up to Rs. 10,000 each year. So, only interest over and above this threshold is taxable.

The message is simple. When you open a savings account and deposit some funds in it, your money isn’t just lying idle there. It is making you more money. The interest rate on your savings account determines how much interest you earn on a daily basis. But the bottom line is that since you know this now, you can choose your banking partner accordingly and maximise your SB account interest.

The interest rate on savings accounts in India can vary from 3.5% per annum to 7.8% per annum, in general. At first glance, a good interest rate is always one that is higher. That said, the interest rate is not the only factor to consider when you are planning to open a savings bank account. There are other factors that matter, too, like the minimum balance requirement, banking facilities, service charges and other fees.

For instance, a higher rate of interest coupled with high transaction fees may not be a good deal. Instead, a slightly lower rate of interest may be a better choice if it comes with no transaction charges.

The interest on your savings account is calculated on your account balance each day. Then, the interest is credit to your account either every quarter or every month, depending on the bank’s policies. This interest is compounded, meaning that you will also earn interest on the interest deposited in your account.

You can visit your banking partner’s website to check the interest rate on their savings accounts. Alternatively, you can even reach out to the customer support team to find out how much interest you earn on your savings account balance.

The interest on your savings account is compound interest. So, you get exponential returns simply for saving up diligently. Isn’t that the best incentive to open a savings account and start saving up for your future?

No, not necessarily. There are several other factors that you need to think of before opening a savings account, such as —

- The minimum balance requirement
- The size of the banking partner’s network
- The service charges and ancillary fees that the bank charges
- The range of banking facilities offered
- The option to bank online

No. Banks and financial institutions may change the rate of interest on your savings account based on the repo rate changes or other factors. In that case, the interest rate on your SB account balance will also increase or decrease accordingly. This will, in turn, affect how much interest you earn on your savings account balance.