Floating-rate FDs only on a rising interest regime

IDBI Bank on Wednesday launched a retail term-deposit product which offers floating rate interest. In this case, the rate of interest is not fixed for the entire maturity of the deposit, but moves in accordance with a reference which is reset periodically. The interest rate in case of the Floating Rate Interest on Retail Term Deposit (FRTD) is anchored to the 364-day Treasury Bills Auction undertaken by the Reserve Bank of India (RBI) during the preceding three months. The interest would be reset every calendar quarter.

According to a release issued by IDBI Bank, the minimum amount for the deposit is Rs 10,000 and thereafter in multiples of Rs 1,000, with a cap of Rs 1 crore.

Currently the yield on the 364-day T-Bill is 8.12 per cent. The rate offered by IDBI Bank on a one-year fixed rate term deposit of up to Rs 1 crore is nine per cent.

The FRTD has a lock-in period of one year and would be accepted in six maturity slabs, ranging from one year to 10 years. Customers can switch from fixed to floating interest rate term deposits by closing the former at the originally contracted rate, without any premature penalty.

However, no conversion of floating to fixed rate is permissible. As in the case of term deposits, it is possible to take a loan or overdraft against the FRTD as well. In September 2010, State Bank of India had launched a similar product.

When should you opt for it?
Keeping your money in FRTDs is a good option when interest rates are expected to rise. Retail investors who have taken loans, can use these deposits to hedge their interest rate risk. Earlier, retail investors used to borrow at a floating rate and earn interest on their deposits at a fixed rate. During times of high inflation, these deposits can provide a cushion for investors. But now, with indications that interest rates have peaked and would start declining gradually, these may not be the best option.

What should you look at?
Falling interest rates are your worst enemy when going for such deposits. One can’t really predict how low it may go, providing no guaranteed returns. This makes it a risky option for people looking at steady earnings.

With interest rates changing often, these may not be a great alternative to fixed term deposits. This is especially true for senior citizens, who rely on a fixed deposit’s regular income and stability. These products are also considered complicated in nature. So, to make the most of them, the depositor needs to know in which direction will the interest rates move, so as to not fall short of the fixed term rates.

Depositors also have the option of breaking their existing FDs and moving onto one in the higher slab, in case interest rates do rise. Most government banks today don't charge a penalty in such cases.

Whether banks will reduce deposit rates or not depends to a large extent on whether the RBI will cut its key short term rates. However, the corresponding rate change by banks happens with a lag and is not uniform.

A further rate hike by RBI will happen only if inflation shoots up by 200 basis points, which seems unlikely. Inflation may, at best, move up by 50-75 basis points due to the drought, say experts.