Due to a change in the method of calculation of interest to be paid on your savings account balances, you would be earning a lot more as interest – even when the rate of interest is unchanged (3.5% per year). Understand what is changing, and how you would benefit from it.
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If you have a savings account in a bank – like most others – you have reason to be happy. Starting today (1st April, 2010), you would earn more on the money lying in your savings account. |
No, the rate of interest is not changing – it is still a pathetic 3.5% per year. However, the method of calculating the interest on your balance is changing. This has been mandated by the Reserve Bank of India (RBI).
How was interest calculated till now?
Till now, you used to earn interest on the minimum balance in your account between the 10th and the 30th of a month. The interest was calculated once a month at the end of every month, depending on the lowest balance between the 10th and the 30th of that month.
Thus, if the balance would be less even on a single day between the 10th and the 30th of any month, you would earn interest on that low amount for the whole month.
The new method of calculating interest
Going forward, the interest would be calculated based on the daily balance in your savings account. The interest would be calculated every day, and would depend on that day’s closing balance.
(The interest would continue to get deposited in your account at the end of every quarter, though – only the method of calculating the interest is changing, not the interest payment frequency).
Thus, any fluctuation in the balance in your account would not have a disproportionate impact on the interest you earn for the whole month.
This is the right way of calculating the interest – shouldn’t you get interest on the money you actually have in your account, instead of some minimum balance? So, why was this not done till now?
Reason for this change in the method of calculating the interest
My take on this is: computing power.
Earlier, all the interest calculations were done manually. Therefore, to make it less time consuming, it made sense to calculate interest only once a month, and using a rule of thumb to get only one figure to calculate the interest for (minimum balance between the 10th and the 30th of a month).
Now that computing power is very cheap and all accounting in banks is computerized, it is very easy to calculate interest any number of times or at any interval. Therefore, the system can easily switch to calculation of interest based on daily balances.
Does this change help you?
If you don’t like any extra money lying in the savings account, and invest it in various avenues immediately, this change would not impact you much.
However, if you have a lot of money lying around in your savings account, and it keeps fluctuating during the month, then you would benefit a lot from this change in the calculation rule.
Example / Illustration
Let’s consider a scenario to understand this.
(Please download the spreadsheet to see the full calculations. You need to be logged-in to download the spreadsheet. Please take advantage of the free registration that takes less than a minute. To know the benefits of registration, please click here.)
Let’s say the starting balance in your savings account on the 1st is Rs. 45,000. Your salary of Rs. 40,000 is deposited on the 1st, taking the balance up to Rs. 85,000.
For household expenses, you withdraw Rs. 10,000 on the 2nd, the 12th and on the 22nd. Thus, the balance on 22nd is Rs. 55,000.
On 25th, your fixed deposit matures, and an amount of Rs. 60,000 is credited to your account. Thus, the balance at the end of the month (on 30th) is Rs. 1,15,000.
(Please read “Fixed Deposit (FD) – A favourite for generations” to know more about fixed deposits)
Old method of calculating interest: As per the old method, you would earn an interest of Rs. 160.42 for the entire month. This is calculated based on the lowest balance between the 10th and the 30th of the month – which is Rs. 55,000.
New method of calculating interest: As per the new method, you would earn an interest of Rs. 224.38 for the month. This has been calculated using the daily balances in your savings account.
(Please download the spreadsheet to see the full calculations. You need to be logged-in to download the spreadsheet. Please take advantage of the free registration that takes less than a minute. To know the benefits of registration, please click here.)
Conclusion
Due to the change in the method of calculation of the interest, you would be earning more interest from your savings account in spite of there being no change in the rate of interest! Enjoy…
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First, thanks a ton for this extremely useful website.
There a lot of data on the Internet about tax slabs and rates for various incomes (salary, STCG, LTCG, housing, FC, etc), but I see a singular lack of data about tax treatment of savings bank interest. Got a couple of queries for you in this regard:
1. Is it true that the complete SB interest earned in a year is added to the total income and taxed in the relevant slab? There is no exemption?
2. What happens when the interest for the last 6 months of the FY is actually paid in the next year. i.e. I was paid SB interest in April 2010 for a period of Sep 09 – Mar 10. I would assume that since the amount was actually credited to my account in FY 10-11, this sum is not to be considered income in FY 09-10.
Thanks in advance for your answer.
VERY USEFUL ARTICLE.
Good and useful info.Is this applicable to NRE savings bank accounts too.
dear sir, pl let me know ,if i donot want to fix my money as fixed deposit, whats the better alternate to get more interest on money lying idle on saving a/c.?
– rose
Thanks for this informative article; Also please enable favorating a particular article so that when we log-into our a/c we can directly go to those article.
I would like to know more about careers in personal finance management.
Thanks
I am not able to download the excel sheet mentioned in the exercise. I tried login /registration also but that is not working here. I need this excel sheet for interest calculation. Please help, Raag.