Making a fixed deposit in a bank has always been the preferred investment tool for Indians as it gives guaranteed returns over a period of time. Floating rate fixed deposit is a modified variant of the traditional FD, where the return on investment is linked to a reference rate like the Repo Rate of the Reserve Bank of India. Generally, fixed deposits have a fixed rate of return which remains the same throughout the tenure of the fixed deposit. While floating rate fixed deposit does not require a fixed interest rate for the entire duration of the investment, but changes along with the reference rate.
There are two ways in which an investor earns interest on fixed deposits in the bank. These include fixed-rate deposits and floating-rate FDs. Since fixed-rate deposits offer guaranteed interest over a period of time, the interest rates in floating-rate FDs keep on changing.
What is a Floating Rate Fixed Deposit?
As its name suggests, fixed rate, that is, the return on investment in it, is floating, i.e., it varies while in traditional fixed deposits, it always remains the same. Suppose you make an FD of Rs 1 lakh at the rate of 7.5 percent interest for 5 years, then at the end of the tenure, you get a total of Rs 1,44,995. Now there will be no change in this amount and you will get this amount for sure at the end of the investment as the rate is going to remain the same in traditional fixed deposits. There is no change in this return whether the interest rate increases or decreases.
But the interest rates on floating rate term deposits keep on changing. Here the interest rate is linked to a benchmark interest rate and that is the repo rate of the RBI. If RBI increases its repo rate, then the return on this floating fixed deposit will also increase and this return will decrease in case the repo rate is working.
Floating Rate Fixed Deposit and Repo Rate
The floating rate FD always follows the repo rate of the RBI and it does so because the repo rate has a great influence on the inflation rate of the country. When the repo rate rises, it is expected that inflation will also increase and in this situation, the interest rate of floating fixed deposits will also increase. And if the repo rate is reduced then inflation is also expected to come down and this time the returns of floating fixed deposits will also be reduced. This means that it always keeps itself above the inflation rate which is a good thing for an investor.
Why do you need a Floating Rate Fixed Deposit?
A floating rate fixed deposit is also called a floating rate fixed term deposit. Making a fixed deposit in a bank has always been a safe investment option for Indians. Because depositing the amount on FD gives guaranteed returns on maturity. But in the last few years, the interest on FDs has come down continuously, so the returns on fixed deposits have been affected and reduced. Since the interest rates are constantly changing and they are always increasing and decreasing, then this also affects the interest available on all types of savings schemes and loans. In such a situation, a floating rate fixed deposit can be a better option for people who have FD.
Why do banks increase deposit rates?
Banks are an important unit that plays their role in controlling the inflation of the country. Banks deposit money from people such as fixed deposits and then forward the same money as loans. That’s why most banks want to keep the loan rate as high and the deposit rate as low. This increases the net interest margin of the banks. At the same time, the deposit rates also change due to the credit deposit ratio. If this ratio is less then banks can give more loans.
Advantages and disadvantages Floating Rate Fixed Deposits
- The return on a floating rate fixed deposit reduces when interest rates fall while the interest rates on a fixed rate deposit do not change and remain the same all the time.
- On the other hand, the interest earned in floating-rate fixed deposits increases when the repo rate increases, but customers making fixed-rate deposits do not get the benefit of increasing interest rates.
- There are some complications associated with investing in floating-rate fixed deposits. On the other hand, a fixed deposit is very straightforward and simple.
- While making a fixed-rate deposit, you can withdraw money only after the maturity of the deposit. Still, on floating rate FD, the facility of withdrawing money is provided intermittently and there is no additional fee or penalty on it.
Is Floating Rate Fixed Deposit Beneficial?
Fixed-rate deposits and floating-rate fixed deposits both have their own advantages and disadvantages. However, floating-rate fixed deposits earn less interest than fixed-rate deposits. But if you think that interest rates may increase in the future, then floating-rate fixed deposits can be a profitable deal for you. On the other hand, if the interest is low, then the return on it decreases. Whereas the returns you get in fixed-rate deposits are not affected. Therefore, keeping all these things in mind and according to the tenure of your finance, you can choose between these two.