Interest income on savings account set to rise

Saving bank account holders will see a rise in interest income from April 1 onwards. This is not because interest rates have changed. It still stands at an abysmally low rate of 3.5% p.a., but what has changed is the way banks will now calculate interest income on the savings account. RBI has notified banks to adopt a new mechanism for calculation of interest from April 1, 2010 onwards, whereby interest will have to be calculated using the “daily balance method.”

What is the “daily balance method”?
Interest income will be calculated @ 3.5% p.a. using the day end balance. Let’s look at an illustration to see what this means and how this methodology will work.
Illustration
Below is a snapshot of the transactions executed by Mr. Atul, pertaining to his saving bank account for the month of April.

Interest calculation would be as under

Balance * number of days *%Interest per annum / number of days in a year

For the month of April interest calculation would be as under

Mr. Atul will receive Rs. 177 as interest income for the month of April.

How is the new method any different from the earlier method?

Under the previous methodology, banks would compute interest @ 3.5% p.a. on the lowest available balance in the account between the 10^th and the last day of the month.  This meant that if you withdrew money any time after the 10^th day of the month, even if it meant the last day of the month, you would end up losing interest as  your account balance would reduce and interest would be calculated on the lowest balance. Also, any deposit made by you during the same period (between the 10^th and the end of the month) would not make any difference to the interest income calculation as a higher balance does not impact it.

What will My Worth be with a Limited Monthly Savings? Click here.

For the account holder, it would not make economic sense to have a high account balance on an average because if the account balance falls even on a single day between the 10^th and the last day of the month, that low figure would be used for interest calculation resulting in loss of interest income.

To understand the impact monetarily, let us see what Mr. Atul’s interest earnings would have been under the old method of interest calculation.

The lowest balance between the 10^th and the 30^th of April was Rs. 30,000. So Mr. Atul would receive interest to the tune of Rs. 86 {Rs. 30,000*30*(3.5/100)/365}. So in spite of having a balance much higher that Rs. 30,000 for most of the month, Mr. Atul would end up losing interest because, he withdrew on the 21^st of the month thereby reducing the balance in his account.

From the account holder perspective, this methodology of calculating interest income was unfair as he would not get the advantage of having a high balance on an average in his account.

What does the new methodology of interest calculation mean for account holders?

• Interest income on the savings bank account will rise- Mr. Atul will receive an additional interest of Rs. 91 (Rs. 177 – Rs. 86) under the new method as against the old method of interest calculation
• Fluctuations in the account will not have a disproportionate impact on the interest earned
• Reduces the worry of timing  withdrawals and deposits
• No need to look at other avenues for parking funds for short intervals- liquid funds, short term fixed instruments

The new mandate by RBI is a feather in the cap of the investor community. After all, shouldn’t you get interest on the actual amount you have in your savings account rather than on the minimum balance?

For more details visit: www.rupeetalk.com

No related posts.