Why Do Fixed Deposit Rates Fluctuate?
Yash Desai, a sales executive from Pune, wanted to lock his money in a fixed deposit. When he approached his bank, he was told the FD would be made at a rate of 7%. This was surprising because his friend had made a similar investment just a couple of months back at a rate of almost 9%.
Yash asked the bank executive about the discrepancy and she explained that the RBI had decreased the repo rate recently, which resulted in a drop in the FD rates.
There are many factors that contribute towards the fluctuations in FD rates. In this article, we explain the various reasons so that you get a better understanding of how the fixed deposits work. Take a look.
What is a Fixed Deposit?
To begin with, let us understand what a fixed deposit is. A fixed deposit is a financial scheme where you lock in a particular sum of money at a fixed rate of interest. You cannot withdraw the money before the term ends. The money fetches you interest. The fixed deposits are protected against any fluctuations in interest rates. Therefore, they are considered to be one of the safest investment tools.
How Do Fixed Deposits Work?
Banks and NBFCs are in the business of money.
You give them money through deposits. In return, the financial company promises to pay an interest. The rate of interest differs with the tenure of the deposit. The longer you promise to deposit the money, the higher the rate.
This is because it allows the financial company to use the money more easily. It lends this money. The borrower promises an interest on this loan. This rate is higher than the interest rate promised on the deposit.
Once the money is returned along with the due interest, the financial company pays the depositor his/her interest along with the principal amount.
The interest rate on the loan is higher than the interest on the deposit. This is where the financial company earns its money.
Additional Read : Loans Against Fixed Deposits – All You need to Know
So when the interest rate on the loan changes, the deposit interest rates too change.
Factors That Affect the Fixed Deposit Interest Rates
Now let us take a look at the factors that affect the FD interest rates.
- RBI repo rate: The Reserve Bank of India (RBI) lends money to all the other banks in the country. The rate at which the money is given is known as the repo rate. When the RBI repo rate is lower, the lenders have to reduce their loan interest rates. So, the FDs interest rate too falls.
- Credit demand: The demand and supply of the credit in the economy also plays a role here. When there is a high demand for credit, the financial companies usually increase the FD rates to get in more cash into their vaults. Similarly, when the credit demand is low, the FD rates are slashed.
- Economic standing: Another factor that affects the FD interest rates is the economic condition of the nation. During a poor economic phase, the RBI cuts interest rates to allow banks and NBFCs easy access to cash. This in turn lowers the interest rate in the markets, stimulating borrowing and demand. At such a time, FD rates rise to encourage depositors.
- Type of FD: The kind of fixed deposit you opt for will also determine the overall interest you earn. If you opt for a cumulative fixed deposit, you earn interest on your interest payments. This increases your overall return.
The bottom line:
FD’s are wonderful saving options but as the rates of interest do fluctuate over time. The key, therefore, is to keep investing over time.