A Comprehensive Guide to Understanding Why Fixed Deposit Interest Rates Fluctuate
Fluctuations in fixed deposit interest rates intrigue investors across all age groups. While we know that the Reserve Bank of India’s announcements on policy rates like Repo, CRR, Reverse Repo and the bank’s own MCLR rates give a direction to the fixed deposit rates, there is usually no clarity on this matter.
If you were to go to a bank’s interest rate page, you will see various tenors like 7 to 45 days, 46 to 179 days, 180 to 210 days and so on which will finally go to a maximum limit of 10 years. These are known as “Tenor Buckets” and are important segments in which each bank determines its interest rates. These distinctions are important to determine which tenor’s interest rate needs to be tweaked on an ongoing basis by the bank.
How it all begins?
The apex bank of India, Reserve Bank of India (RBI) controls the flow of liquidity in the country by adjusting the policy rates as below –
- Repo Rate – This is the rate at which RBI lends to the banks. During high inflation when the RBI wants to reduce the money available in the system, it raises this rate, thus making it expensive for banks to borrow money from it. Same way the rates for borrowers will increase as well. Consequently, banks as well raise their fixed deposit rates as they want to raise more money from the public.
- MCLR (Marginal Cost of Funds based Lending Rate) – though this is more related to the lending rate, it is an important determinant for fixed deposit rates. Implemented by the RBI on April 1, 2016, it is an internal rate of reference for banks below which they cannot lend. It takes into account the additional cost of arranging a loan for a prospective borrower. Hence customers with different risk perspective are offered different rates of interest.
- Cash Reserve Ratio – this is the percentage portion of loans given by commercial banks which need to be deposited with the RBI in the form of liquid securities/cash. When the RBI cuts the CRR, the same money can be diverted into the economy for lending, thus increasing liquidity. Thus, this increase in liquidity reduces the need for deposits from the public and banks and NBFCs cut the fixed deposit rates.
- Bank’s Net Interest Margin –Banks and other financial institutions in lending and borrowing measure their revenue by the difference of earnings on lending minus the interest paid on deposits. This is known as the Net Interest Margin. Banks also cut the deposit rates on certain tenors keeping an eye on their revenues.
- The rate of inflation – If the rate of inflation is high, banks as well get negative revenues, and they are unable to raise fixed deposit rates.
- Anticipation – With the signals that the RBI gives on the credit offtake in the economy, banks may reduce or increase the deposit rates depending on whether money from the public is required or not.
- Demand and Supply – Banks and NBFCs use the deposit amounts to lend to borrowers. If there is no demand for this credit offtake from home loans and businesses due to a lull in the macro-economic conditions and business environment, banks reduce the fixed deposit rates and vice versa if the demand is high.
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