12 Aug 2015

Better Sweep Accounts

Sweep accounts combine the higher interest rates of FDs with the flexibility and convenience of bank accounts. But they are needlessly complex, and give you a lower return than theoretically possible.

To begin with, it would be far simpler if banks just offered accounts with the same interest rate as the highest-paying FD, like 8% [1]. That eliminates the complexity of having multiple FD accounts within your account.

When I log in to SBI, I see a dozen or two FD accounts, each of which has an account number, a balance, a deposit date, a maturity date, and a maturity amount. When I want to know my balance, it usually shows me the balance of just the savings account rather than the combined balance. This is on the web site and in SMSs. This worried me many times, thinking I’d lost most of my money. This is exactly the kind of stupidity you expect from SBI.

I also see tons of transactions on my statement caused by transfers between the savings account and FDs. These add so much noise that it’s hard to see what the real transactions are. I recently found some money missing in my account. I had a balance of, say, ₹20K, and I deposited another 10K, so I expected to have a balance of 30K. With a plain savings account, this is easy: check the balance after each transaction listed in the statement. With an SBI sweep account, each line item in the statement lists only the balance in the savings account, so the statement becomes useless to trace the missing money.

A plain savings account with an FD-equivalent interest rate, like 8%, eliminates all this complexity.

If that can’t be done, that is, if FDs must be created, they should at least be created for the term that results in the highest interest rate, as of that date. That is, whenever you deposit money in a sweep account, an FD is created. The way sweep accounts work today is that the FDs are created with a fixed term, like 180 days in case of Kotak. Some banks let you choose the FD term at the time of opening the account, but after that it’s fixed. It would be better if, whenever you deposit money in a sweep account, the bank checks FD interest rates as of that day, and automatically picks the term that has the highest rate. That way, you’ll earn the highest interest possible.

Similarly, when you’re withdrawing money from the account, and an FD has to be broken, the one that’s earning you the least interest should be broken. If you have one that’s paying 6% and one that’s paying 7%, break the former. Banks currently follow a fixed order of breaking FDs, like last-in first-out policy for SBI. Other banks are worse, like Kotak, which does first-in first-out. This means that if you’re constantly transacting on your account, no FD will reach maturity, so you’ll earn low interest on all your FDs. Neither FIFO nor LIFO is optimal. What’s optimal is breaking which ever FD is paying you the least interest rate as of that date.

This is assuming that only the required amount is broken from the FD, rather than the whole FD. In other words, if you have an FD for ₹10K, and you’re withdrawing ₹6K, and your savings account balance is zero, it should break only ₹6K from the FD [2]. Banks have no excuse to break more than is needed.

Banks should also stop imposing silly restrictions, like a minimum limit of ₹10K for each FD that’s created. Or, worse, that FDs can be created only in multiples of ₹10K, as with Standard Chartered. And there should be no penalty to break an FD, as with Yes Bank, because the bank is doing that automatically. Yes Bank has a particularly dumb system where, when an FD is created, the savings account balance can dip below a minimum and cause a penalty, despite the total amount in the sweep account being more than the minimum.

In summary, banks should do away with sweep accounts and instead offer plain savings accounts with FD-equivalent interest rates, like 8%. If that’s not possible, sweep accounts must create FDs with the term that results in the highest interest rate, and break FDs that are paying the least interest. And do away with other dumb restrictions.

[1] This can keep changing with RBI rates. So, I might get 8% this year, and 9% the next year, and maybe 7% the year after that, depending on the RBI rate.

[2] An alternative but equilvanet way of thinking about this is that a separate FD is created for each paisa deposited in the account.

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