Understanding Floating-Rate Term Deposits

The recent hike in repo rates by the Reserve Bank of India (RBI) has put the spotlight on floating rate or floating-rate term deposits (FRTDs) as an investment instrument. 

As the name suggests, in FRTDs the interest rate is not fixed for the deposit tenure. Unlike regular fixed deposits, in floating-rate fixed deposits, the interest rate moves in tandem with a certain reference rate (repo rate, for instance), which is revised periodically. An investor gets the benefit from any interest rate changes without closing or re-booking the FDs. 

A few of the terminologies regarding FRTDs include:

Mark-up/ Spread: It is the fixed premium or additional rate of interest that a bank offers over and above a base rate or benchmark, which could be the repo rate.

Benchmark rate: It is the rate that is used as a standard or base to pay the interest rate for deposits and loans.

Reset frequency: It is the frequency with which the floating-rate changes.

Penalties on premature withdrawal/ liquidation of deposits: Banks tend to charge a penalty when an investor withdraws from FRTD, which could range from 0.5-1% of the interest rate.

There are two options available under the floating-rate FD schemes.

For instance, Yes Bank offers a floating rate fixed deposit, where it has set a floating interest rate of 7.0% on deposits maturing in up to 18 months and 7.5% on those maturing in up to three years. 

Similarly, IDBI Bank offers FRTD linked to the 91-day treasury bills (T-bills) and 364-day T-bills. An individual can deposit Rs 10,000-1 crore under this product and the interest is paid by the bank on a quarterly basis. Interest reset occurs every calendar quarter. The tenure for the floating rate deposits ranges from 1-20 years.

Practically speaking, for those with an investment time horizon of medium-term of up to three years, then opting for an FRTD may provide the advantage of above-average return during this period. There is a higher risk of interest rate reduction in the case for any period longer than this.

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