Rupakumar Pradhan, CFPCM, CWM®

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How Do Banks Calculate Interest on Your Savings Bank Accounts?

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How Do Banks Calculate Interest on Your Savings Bank Accounts?

How Do Banks Calculate Interest on Your Savings Bank Accounts?
August 08
15:38 2017

 

The Reserve Bank of India deregulated savings rate in October 2011, but State Bank of India, other public sector banks and private banks such as ICICI Bank and HDFC Bank held their rates steady. Kotak Mahindra Bank, YES Bank and IndusInd Bank upped their savings bank rates.

Recently, State Bank of India, the country’s largest bank, on 31st July 2017 introduced a two-tier interest rate structure for its savings bank accounts, reducing interest rates for most of its depositors.

SBI cut interest rate on savings bank account deposits up to Rs 1 crore by 0.5 per cent to 3.5 per cent, lowest in six years. It will impact 90 per cent of its savings bank account holders.

If other banks now follow the SBI in lowering rates, private banks and small finance banks, which offer more than 4 per cent, could gain deposits.

On a savings bank deposit base of Rs. 9.40 lakh crore (of which 90 per cent is in the below – Rs.1 crore category), SBI could save about Rs. 4,000 crore from the 50 basis points cut.

Savings Account

For All, Savings Account is one of the basic financial products that everyone must have and use. A savings account will let you save money, transfer funds, withdraw money and also will give you interest on the funds that you have in your account. Not many investment products in the market give you the dual benefit of liquidity and interest.

But, a savings account will not only help you save some money but will also let you withdraw cash whenever you need it.

Depositing money in a savings account will help you realize your short term financial goals with ease. With banks offers different types of savings account such as specialized accounts for kids, savings account for women and pensioners savings account, you can choose a savings account that fits your lifestyle and usage.

One of the key points to note about a savings account is its interest rate.

Read on to find more about how savings account interest rate is calculated.

How do banks calculate interest on your savings bank accounts?

Many wonder how banks calculate their savings account interest.

Let us understand this process with an example:

Effective from April 1, 2010 onwards, following RBI’s mandate to rework interest rate calculation methods, banks started calculating interest on a ‘Daily Balance Method’.

Earlier method of interest rate calculation

Earlier, banks would pay interest at the rate of 3.5% p.a. on the lowest available balance in the account between the tenth and the last day of the month.

Any deposit in the account between the tenth and the end of the month, would not earn the account holder any interest as it is not part of the interest rate calculation.

Any withdrawal between the same period would result in lower interest income as the lowest balance would be taken into account for the calculation.

Example:

Mr. Saver had an account balance of Rs 85,000 on April 10. He received a payment of Rs 300,000 on April 15 from the maturity of his fixed deposit.

On April 29, he made a down payment of Rs 320,000 to a builder for a property. This resulted in his account balance reducing to Rs 65,000. For the interest income calculation for the month of April, the bank would take Rs 65,000 as the base and pay him interest on that amount. So interest due to Mr. Saver would be on Rs 65,000 for 30 days @ 3.5% p.a. which would be Rs 187.

In spite of having a high account balance for most period of the month, Mr. Saver lost interest income for the month.

Under this method of interest rate calculation, the best thing Mr. Saver could do is ensure that all transactions are done between the first and ninth of any month so that he would get benefit of interest. This required proper planning.

New method of interest rate calculation

Interest will be paid @3.5% p.a. on the ‘daily balance method’ in the account at the end of the day. Here, the account holder will get interest on the actual day end balance.

Under this method, Mr. Saver’s interest income calculation would be:

For the first 14 days of April, interest to be paid would be calculated on Rs 85,000;

For the next 14 days of April, interest to be paid would be calculated on Rs 385,000 and;

For the balance 2 days, interest to be paid would be calculated on Rs 65,000.

So the total interest due to Mr. Saver would be Rs 643.

Under this method, Mr. Saver’s interest income is higher by Rs 456!

Besides, he did not have to plan his withdrawals and deposits as he would receive interest on the actual account balance.

As a savings bank account holder, you should be pleased with the latest change. Who would not like to see higher balance on account of higher interest income?

Interest rate calculation Formula

Monthly Interest = Daily Balance * (Number of days) * Interest / (Days in the year)

“When interest rates are high you want the average direction in which interest rates are moving to be downward; when interest rates are low you want the average direction to be upward.” -John Hull

TDS on Savings Account Interest

The interest amount that you gain from a savings account is referred to as “Income from Other Sources”. This interest must be filed for Income Tax Returns. But, TDS is not applicable for a savings account as per section 194 A of IT Act .

Savings Bank Account Interest amount exceeding Rs. 10, 000 will be taxed at marginal tax rate of the concerned account holder. It is also important to note that interest from a savings account is not an exemption but a deduction.

The deduction is allowed for interest incomes up to Rs. 10, 000 only and for this purpose, the savings account must be held with a recognized public or private bank or with the Post Office.

 

I am a CERTIFIED FINANCIAL PLANNERCM. For the moment, I have shared my experience growing up with you because it had a tremendous impact on how I do what I do.

If you have a question about your own financial situation please connect with me.  I’d be delighted to try to be of service.

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About Author

Rupakumar

Rupakumar

Mr. Pradhan has over 22 years of experience in financial services industry. He was previously working with leading Life Insurance Companies, Broking Firms, Distribution Company, Financial Planning Company and Health Insurance Company. He has cleared several NCFM modules & is also AMFI Certified. His expertise is in Comprehensive Financial Planning, Technical Analysis, Portfolio Management, Investment Advisory, Wealth Management & Business Development.

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5 Comments

  1. Sheetal
    Sheetal August 08, 17:45

    A very enlightening article. Sure, Mr.Pradhan shows the mettle he is made of when it comes to finance. Good learning for me.

    Reply to this comment
  2. jagan
    jagan August 09, 00:37

    Sir axis bank also reduced there int rate

    Reply to this comment
  3. jagan
    jagan August 09, 00:40

    Sir axis bank also reduced to 3.5

    Reply to this comment
  4. shrikant
    shrikant August 09, 04:06

    Very pleased with this latest info thru simple calculation example

    Reply to this comment
  5. Saroj
    Saroj August 09, 14:55

    Its really unknown to me earlier
    Thanks for such valuable knowledge.

    Reply to this comment

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