Consider moving funds to a variable rate fixed deposit from a regular fixed deposit
The bank offers a mark-up of 1.10% on this rate of 4.9% for a FD of 1 to 1.5 years (bringing the total interest rate to 6%). For 1.5 to 3 years, the bank offers a Mark up 1.6% from the repo rate of 4.9% bringing the total interest rate to 6.5%. The mark-up rate is the additional interest rate offered on top of a base rate which is here the repo rate.
What makes this instrument attractive at the moment is that in the short term, interest rates are likely to remain high (with inflation on an upward trajectory), so interest rates in variable rate deposit will also increase. The repo rate is the rate at which the RBI lends money to commercial banks and it is regularly reviewed by the RBI to monitor liquidity in the market. The RBI has already hiked the repo rate twice this fiscal year (up 40bps to 4.4% in May and 50bps to 4.9% in June) and markets expect to further increases.
Below is an illustration of how the client can benefit from investing in a variable rate FD versus a fixed rate FD. Although the amount invested remains the same, the after-tax interest earned is higher in a variable rate deposit.
Until now, most banks in India only offered fixed rate FDs. And most advisors recommended “laddering” to their clients to take advantage of high interest rates and liquidity.
Ravi Sraogi, SEBI Registered Investment Advisor and Co-Founder samasthiti advisors says that this ‘staggering’ meant that investors with, say, a corpus of Rs 5 lakh, would keep Rs 1 lakh in a 3 month FD, another lakh in a 6 month FD and maybe another lakh in a 1 year FD. The remaining amount of Rs 2 lakh would be kept in a longer tenure of 2 or 3 years FD. While smaller amount FDs would be helpful for sudden liquidity needs, larger amount deposits would be helpful for earning higher interest rates. With this new variable rate instrument, the depositor does not have to keep up with the multiple deposit amounts and interest rates they earn. The interest rate of the variable rate FD is automatically reset each month, based on the repo rate that prevailed the previous month.
Usually, when interest rates go up, banks immediately raise loan rates and EMIs paid for home loans are the first to go up because home loan rates go up quite quickly.
However, the same is not true for time deposits, as banks take their time offering higher rates. This makes the current offer of a floating rate FD attractive.
Overall, most banks agree that interest rates will rise and their FD rates will also rise. But no one knows when that will happen. Currently, the private sector bank ICICI bank offers its clients 5.35% for FDs of 1 to 2 years and 5.5% for FDs of 2 to 3 years. HDFC Bank also offers similar rates on its term deposits. Other banks may also consider floating rate FDs, but from now on we will have to wait and see.