What are floating rate term deposits?

Floating rate term deposits (FRDs) are a variant of the fixed deposits offered by banks. The interest rates on offer are linked to the bank’s base interest rate. This is a relatively new product in the country, with the first one having been launched by State Bank of India in September 2010. As of now, these deposits are only long-term in nature, offered for periods of 1, 3 and 5 years. One can invest a minimum of Rs 1,000 and multiples thereof, till a maximum of Rs 15 lakh. The interest rate changes each time the base rate does, and can move up to a maximum of 200 basis points above the fixed term deposit rate.

How are they linked to the bank’s interest rate?
FRDs have their interest rates linked to the bank’s base rate, which varies with the benchmark rate revisions. Depending on the deposit tenure, the rate changes to narrow the gap between itself and the prevailing base rate. It is inversely related to the tenure of the deposit. For instance, while the interest rate offered by a one-year floating deposit is 50 basis points lower than the base rate, that of a three-year deposit is 25 basis points lower. The rate for a five-year deposit is at par with the base rate.

Why should you opt for it?
Keeping your money in FRDs is a good option when the interest rates are expected to rise. Retail investors who have taken loans, 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. Also, during phases of high inflation, such as now, these deposits are a good option, as interest rates are expected to rise.

What should you be looking at while opting for FRDs?
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.