Why Do Banks Ask Us to Maintain a Certain Average Monthly Balance?

Banks often request that customers maintain a certain average monthly balance (AMB) in their accounts. This might seem like an arbitrary rule, but there are several important reasons behind it. Not all banks enforce this policy, but for those that do, it serves a specific purpose, often aligning with their business objectives and operational needs.

Cost Factors Involved in Maintaining Accounts

Banks incur various costs in maintaining customer accounts. These include the cost of sending out statements, maintaining customer transactions, and managing their computer servers. Since banks can earn interest on deposited funds, this income often offsets these operational costs. However, maintaining high AMB allows banks to ensure a more stable and predictable revenue stream through interest earnings.

Regulatory Requirements and Reserve Ratios

Many banks are required to maintain a minimum reserve ratio, which is the amount of money they must hold in reserve against their liabilities. This is typically stored in their reserve account with the Federal Reserve (Fed). The minimum reserve requirement is primarily for liquidity purposes, facilitating quick and efficient handling of transactions in the form of teller transactions. Excess reserves above the minimum level are considered extra and are not available for lending. These reserve requirements have no direct impact on lending practices.

Banking Infrastructure and Capital Expenditure

Banks invest heavily in creating extensive branch networks, often with thousands of branches across the country. This significant capital expenditure (Capex) for creating operating systems and enabling online banking services also comes at a substantial cost. To recover these costs, banks supplement their income through non-interest income sources. These include charges for cheque return fees, folio charges, credit card late payment fees, and minimum account balance requirements.

For accounts without a minimum balance, banks may charge higher fees for certain services, which can lead to higher overall costs for customers. The formal stipulation of a minimum balance in savings and current accounts (CASA) is designed to keep these costs low. When more customers maintain these balances, it helps in reducing the overall cost of deposits, including term deposits, which in turn increases the banks' net interest margin (NIM).

Profitability Calculation and Revenue Streams

The primary source of income for banks is the net interest margin (NIM), which is the difference between the interest earned on loans and the interest paid on deposits. While this is a crucial aspect of their profitability, the cost of maintaining these balances is another key component. By encouraging higher AMB, banks can significantly reduce their cost of deposits. This, in turn, enhances their NIM, ultimately leading to higher profitability.

Conclusion

The request from banks to maintain a certain average monthly balance is not arbitrary but stems from a combination of regulatory requirements, operational costs, and profit-making strategies. Public and private sector banks alike are keen on attracting more customers to maintain these balances, as it directly impacts their financial health and performance. Private banks, in particular, have been more successful in achieving this goal compared to their public sector counterparts.

Understanding these factors helps clarify why banks might request customers to maintain a minimum balance in their accounts. It also sheds light on the importance of such balances in the broader context of banking operations and customer service.