Floating-rate fixed deposits look attractive for investors

A private bank is offering a floating interest rate deposit. Is it advisable to keep deposits in these floating interest rate deposits?

- BS Patnaik, Visakhapatnam

As the name suggests, in floating-rate fixed deposits, the rate of interest moves up and down, or 'floats', based on a reference rate which is further dependent on prevailing economic or financial market conditions. Floating-rate fixed deposits are a variant of fixed deposits. The interest rate is not fixed but periodically reset for the entire tenor of the deposit. Hence, the interest rate in floating deposits moves in tandem with a reference rate of a benchmark instrument. As the name implies, fixed deposits are investment schemes for a fixed term at the prevailing fixed rate of interest till maturity. One will get the same interest rate throughout the deposit tenure regardless of any change in the reference rate or the market and economic conditions. Unlike market-dependent investments, where returns fluctuate over time, the returns on fixed deposits are fixed at the time of opening of an FD and remain the same till maturity. These fixed deposits are one of the safest investment options that offer guaranteed returns.

A few banks unveiled the floating rate fixed deposit schemes. The minimum amount that can be parked under the floating rate fixed deposit scheme is Rs 10,000, and a maximum of Rs five crore. The minimum tenure that can be placed under the floating rate fixed deposit scheme is one year, and a maximum of three years. Some banks have been offering an overdraft facility on floating rate deposits up to 90 per cent of the principal value.

The interest rate of floating-rate fixed deposit schemes is linked to the prevailing repo rate. Reserve Bank of India, on 4 May 2022, hiked the repo rate by 40 bps to 4.40 per cent from 4.00 percent. RBI increased it again on 8 June 2022, from 4.40 per cent to 4.90 per cent. RBI is likely to hike the repo rate further to arrest inflation.

For example, if an investor opts for a regular fixed deposit that matures in two years @ 5.30 per cent, the rate of interest and maturity value, including interest and return, will remain the same till the date of maturity.

If the customer opts for a floating-rate fixed deposit, the interest rate remains variable throughout the tenure. After reviewing the economic conditions, RBI may reset or revise the benchmark reference rate at regular intervals. Usually, most banks offer the floating-rate fixed deposit with a mark-up of 1 per cent over the prevailing repo rate. Investors earn 5.90 per cent on floating-rate fixed deposits as per the prevailing repo rate. What if there is a cut on the repo rate after six months? The interest rate on the floating deposits will be adjusted according to the reduction in the reference rate. For example, if the repo rate is reduced to 4.00 per cent after three months, then the interest rate of the floating deposit will be automatically set to 5.00 per cent (remember the 1 per cent markup)

Floating rate fixed deposits may benefit customers when the interest rates are likely to move northwards in the coming quarters. Hence, as per the present economic scenario, the floating rate fixed deposits look attractive for investors with a time horizon ranging from one to two years, as the repo rate is in an upward trend. Floating rate fixed deposits may become plain-looking when the interest rates have peaked, and the rates move southward. Like the regular fixed deposits, the banks will levy a penalty in case of premature withdrawals. In a nutshell, floating-rate fixed deposits are ideal and deliver higher returns when the interest rates increase and offer lower returns when the interest rates drop. Ideally, you should distribute your savings to both regular and floating fixed deposits to average the returns. For example, park 65 percent of your money in floating rate deposits and 35 percent in regular fixed deposits and see how they performed over a period. You may taste the dynamic returns on their fixed deposits.