Fixed deposits are one of the most preferred long-term investment options among investors. But, one of the downsides of it is the fixed rate of return through the whole tenure, irrespective of the economic situation.
What if there is a rate that changes with time and offers varied interests to investors? Is it better than the fixed interest rate? Let’s explore this through the concept of floating rate fixed deposits.
What is a floating rate?
A floating rate is a type of interest rate that fluctuates based on market conditions. In contrast to the fixed rate that remains constant throughout the tenure, the floating rate ties itself with a benchmark rate, which varies time and again.
Examples of benchmark rates are repo rates, MIBOR (Mumbai InterBank Offer Rate), etc.
What is a floating rate fixed deposit?
A floating rate fixed deposit offers the facility of fluctuating rates to investors. So, floating rate fixed deposits tie themselves with repo rate, treasury bill yields or other benchmark rates. Each time the benchmark rate changes, the fixed deposit interest rate changes accordingly and offers different returns to investors.
Consider a floating rate fixed deposit following India’s repo rate. It offers investors a 0.5% markup on the repo rate. The current repo rate is 6.5%, so floating rate fixed deposit investors get a return of 7% (6.5 + 0.5).
If the repo rate goes up to 7.5%, the interest rate on deposits increases to 8%.
Pros and cons of floating rate fixed deposits
Fixed deposits are one of the favourable avenues for investors looking at long-term and secure investment options. They offer regular and stable income to investors with minimum risks, unlike other investment platforms like the stock market.
Some investors, however, hold back from investing in fixed deposits because the interest rate is normally fixed, stagnating the earning capacity of investors.
Floating rate solves this issue for investors by offering varied rates over the fixed deposit tenure. When the economy is trending upward, the benchmark rates may react positively, increasing the rates of FDs. This offers a higher return to investors.
The downside to this is that the interest rate offered will decrease when the benchmark rates fall. However, the impact of this is not severely felt by investors, considering the varying rates of returns.
Hedging against inflation is another significant difference between fixed and floating interest rates. A fixed interest rate does not offer any protection or increase returns during inflation or other economic crises. Floating interest rates, on the other hand, can offer a hedge against inflation if it relies on repo rates.
Increasing repo rates during inflation is the central bank’s step towards controlling the situation. This positively impacts floating-rate fixed deposits. As compensation to investors for not hedging risks, fixed deposits usually offer 1-2% higher returns as compared to floating rate deposits.
Banks offering floating-rate fixed deposits
Yes Bank’s floating rate fixed deposit follows India’s repo rate, which is currently 6.5%.
- Any change in the repo rate automatically gets updated in the fixed deposit system.
- Allows overdraft to depositors on fixed deposits.
- Floating rate fixed deposit tenure varies from 1 year to 3 years.
- Yes Bank allows customers to deposit as low as ₹10,000 in floating rate deposits.
- Senior citizens with a deposit amount less than ₹2 crores are eligible for an additional interest at 0.5% and 0.45% for a deposit between ₹2 crores to ₹ crores.
IDBI Bank follows the bank’s treasury bill rates for floating-rate fixed deposits.
- IDBI pays interest to its customers on the last day of every quarter.
- The interest rate automatically resets every three months once, based on the prevailing treasury bill rate.
- Customers have an overdraft facility of up to 90% of the deposit value.
- IDBI does not allow withdrawals for up to one year.
- Senior citizens get an additional interest at 0.5%, over and above the floating rate.
- Minimum amount of deposit – ₹10,000. Maximum amount of deposit – ₹1 crore.
Also read: At what age can you invest in stocks?
Fixed vs floating rates in housing loan
Similar to different rate structures in fixed deposits, housing loans offer different facilities for paying interest. Banks offer both floating and fixed interest rates to customers.
Customers choosing fixed interest rates pay a fixed EMI through the loan tenure, whereas floating rate customers pay according to benchmark rates.
Fixed rates are suitable for customers who expect interest rates in the market to increase. Floating-rate loans are suitable when the customer has no hint about the future direction of interest rates.
Floating-rate fixed deposits offer varying interest rates based on market events. This helps investors take the benefits of an uptrending market. However, they will also be impacted negatively when the economy is falling. Hence, investors must analyse their risk appetite and choose their investment options accordingly.