Whether you have any investments or not, but this is for sure you at least hold a savings bank account, isn’t it? Until RBI deregulated the savings bank interest regime during 2011 we had no concerns how much bank gives interest on the savings. Post the deregulation came into effect banks became free to decide the interest rate they wanted to pay on their savings bank accounts, depending on their liquidity and profitability preferences. Banks now use this as a competing factor and weave it into their merits to enhance their customer base. This certainly helped the customer to earn more interest, as competition has led some banks to increase the interest rate offered. Now Banks like; Kotak Mahindra Bank, Yes Bank are offering saving account interest around 6%-7% than earlier standard rate of 4% across industry.

Banks Savings Account

Many of us wonder how banks calculate interest on these savings accounts. Previously, the interest rate of 4% per annum was applied against the lowest balance available in the account between the 10th and the final day of the month. But this was seen as an unfair method of calculation, as the depositor could not receive full benefits of the amount he/she maintains in his/her account. Thus from April 1, 2010, as per RBI circular which states “The interest has to be calculated on daily basis for the closing day balance”, thereby account holders earn higher interest income.

So, how is interest on saving bank account is calculated?

Let us understand the old and new methods of savings account interest calculation with examples;

How Old Interest Rates were calculated?

As stated, till April 1, 2010 banks used pay an interest at a standard rate against the lowest available balance in the account between the 10th and final day of a month. Any deposits happening during this period were not eligible for interest rate calculation of that month, but at the same time, withdrawals during the period were taken into account. Say for example; you had a balance of Rs. 5,00,000 in your account (assume 4% interest p.a.) as on July 10th. On July 18th, you deposited Rs. 2,00,000 which you received as redemption proceeds of some mutual funds. On 26th July you had withdrawn Rs. 6,50,000 for part payment of home loan outstanding, thereby reducing your account balance to Rs. 50,000. In this case, the bank would consider Rs. 50,000 for interest calculation, as it is the lowest amount available in your account between 10th and 25th July. So, the interest amount you will be eligible for the month of July would be for Rs. 50,000 @ 4% p.a. which amounts to Rs. 169.86 i.e. [50,000×31(4%/365)].

This means, in spite of having a high account balance for most period of the month, you lost interest income for the month. Under this method of interest rate calculation, the best thing could be done, if you ensure that all transactions are done between the first and ninth of any month so that you could get benefit of interest. But this is not so easy to maintain month on month.

How New Interest Rate is calculated?

As per the new method interest rate is calculated on daily basis on your closing amount. However, interest accumulated will be paid quarterly or half yearly depending on the bank. Currently Interest is being paid on the daily balance in the account at the end of the day. Here, the account holder gets interest on the actual day end balance.

The new interest calculation formula is very simple;

Monthly Interest = Amount (Daily balance) × (No of days) × Interest ÷ Days in the Year

If you take the same example as discussed above, with the new method of interest calculation, assuming the interest will be same 4% p.a. then the total interest for the month will be;

SB Interest Calculations

Now the eligible interest for the month would be Rs. 1,578.08 i.e. [{5,00,000×17×(4%/365)}+{7,00,000×8×(4%/365)}+{50,000×6×(4%/365)}]

Taxation of Savings Account Interest:

Unlike interest on fixed deposits, interest earned on savings bank accounts is not subject to Tax Deduction at Source. However, this does not mean the interest earned on Savings accounts is completely tax free. Under section 80TTA of the income tax act, it is exempt upto Rs. 10,000 in a year that means if the interest you earn from savings accounts crosses this threshold, it becomes subject to tax.

How do Banks calculate interest on Savings Accounts?

2 thoughts on “How do Banks calculate interest on Savings Accounts?

  • October 31, 2013 at 11:05 AM
    Permalink

    Very good Article on Interest rate calculation. Simple and well descriptive.
    Thanks for sharing Knowledge.

    Reply
    • October 31, 2013 at 1:19 PM
      Permalink

      You are most welcome Vijay!

      Reply

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