At the end of every quarter, we get messages saying Bank has credited Rs. XX into our account as part of interest, for the amount we had stored in our savings account.

Let us try to find how exactly banks compute interest and how much interest are they giving us.

The rate of interest in savings bank account was 4% per annum as mandated by the government in May 2011. However, with the recent change, banks are now allowed to fix their interest rates for saving account customers. Banks now use this as a competing factor and weave it into their merits to enhance their customer base.

Before deregulation, there was hardly any competition in this segment, and all banks offered the same rate of interest. So, there were no second thoughts for customers about shifting their savings account from one bank to another. However, now customers think twice before they start a new account or wish to switch an existing account to get the maximum benefits.

**So, how it is calculated?**

Earlier banks used to pay an interest rate of 4% p.a. 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.

Let’s take an example and understand this.

Mr. A has 1,00,000 in his account on Jan 1st and its the same on Jan 10th too. And on 15th Jan he receives 1,00,000 from his friend as part of an old settlement. So now he has 2,00,000 in his account on Jan 15th. After that, he withdraws 1.5 lakhs on 29th Jan. So now he has 50,000 in his account by the month end.

Now bank takes into account the least amount in the account between 10th and end of the month. That will be 50,000. Now bank computes interest on this 50,000 and credits him an interest of 166.67 @ 4% interest.

If you closely observe Mr X has an amount of 1,00,000 till the 15th of Jan and then it increased to 2,00,000. This 2,00,000 amount remained in the account for 14 days before 1.5 Lakhs were withdrawn. From this example, we can clearly observe that customer is at the losing end when it comes to the computation of interest on his savings. RBI came into action to change this.

Thus, RBI proposed a new way to calculate an interest that is on a daily basis.

So Effective from April 1, 2010 onwards, following RBI’s mandate to re-work interest rate calculation methods, banks started calculating interest on a daily balance method

Let’s take an example and explore this case:

From 1st to 15th, Mr. A has 1Lakh in his account. That accounts for an interest of 166.67

From 16th to 28th, Mr. A has 2 Lakhs in his account. That accounts for an interest of 288.89

From 29th to 31st, Mr. A has 50,000 in his account. That accounts for an interest of 11.11

Therefore, the interest Mr. A would receive in the new system is 166.67+288.89+11.11 = 466.67

Therefore, he gets an additional interest of 466.67-166.67 = 300 with the implementation of new system proposed by RBI.

Clearly, common man wins in this case thanks to RBI.