RBI allows banks to offer differential interest rates on term deposits

The central bank had proposed early withdrawal feature for term deposits earlier this month

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The Reserve Bank of India (RBI) has allowed banks to offer differential interest rates, based on whether their term deposits are with or without a premature withdrawal facility.

Liquidity or ease of withdrawal, touted as the biggest advantage of bank fixed deposits (FDs), might soon be restricted due to this move.

In its sixth bi-monthly monetary policy review, in February, the central bank had decided to introduce the feature of early withdrawal facility in a term deposit as a distinguishing feature for offering differential rates of interest.

RBI said all term deposits of individuals held singly or jointly of Rs 15 lakh and below should have such a facility. Banks have also been allowed to offer deposits without the option.  

For most banks, the penalty for premature withdrawal of deposits is 0.5-1 per cent below the contracted rate or the rate applicable for the period the deposit has remained with the bank. With withdrawal being made an option, it is possible that term deposits might become less liquid but offer higher returns.

According to Suresh Sadagopan, founder Ladder7 Financial Advisories, taking away the liquidity feature of bank FDs greatly reduces their attraction. If, for instance, they have to be locked-in for three years, it is better to invest in debt mutual funds, which score on taxation, even if the latter's returns cannot be predicted.

RBI has said banks offering such term deposits should ensure that at the customer interface point, the option is given to choose between one with or without the premature withdrawal facility.

Romesh Sobti, managing director at IndusInd Bank, said differential (slightly higher) rates for deposits without the option would help to prevent a drain of funds during times of crisis.

Premature withdrawal from term deposits, especially of higher amounts, can cause problems with banks’ asset liability management (ALM). “For deposits of higher amounts, at the time of withdrawal we have to arrange funds — either by borrowing in the call market or raising from the market. It becomes difficult if the withdrawal is before maturity. The new rule will help in our ALM,” said a general manager, in charge of planning, with a public sector bank.

In case of deposits where premature withdrawal is allowed, banks might offer a lower rate of interest. “Depositors like pensioners, for instance, may prefer to get a higher rate by forgoing the premature withdrawal facility,” the bank official said. The differential might not be more than 25 basis points, he added.

Banks have been asked to disclose in advance the schedule of interest rates payable on such deposits. Banks should also have a board-approved policy on interest rates for deposits, ensuring these are ‘reasonable, consistent, transparent and available for supervisory review/scrutiny as and when required’, said RBI.