Several banks raised fixed deposit rates to meet year-end credit demand. In this explainer, we delve into the reasons behind the recent increase in fixed deposit rates by several banks, whether this increase has reached its peak, and what alternatives investors might consider in the current financial landscape. As interest rates evolve and financial institutions adapt, staying informed about the various options and associated risks becomes paramount to making sound investment decisions.
Why have several banks, including State Bank of India, Bank of Baroda and Kotak Mahindra Bank, raised their fixed deposit rates?
The rise in banks’ fixed deposit rates has been relatively slower compared to the rise in the repo rate. Banks are aiming to make their deposit rates more attractive to attract more deposits, especially with the Reserve Bank of India (RBI) increasing the supply requirement for unsecured loans. This move helps banks manage their assets and liabilities better.
Why have banks raised rates, especially for shorter holdings?
Analysts attribute the recent increase in fixed deposit rates to address the demand for credit, mainly driven by the prevailing high liquidity deficit in the banking system. Banks, struggling with tight liquidity conditions, adjusted rates for shorter tenures to attract more deposits and manage their liquidity.
Is the liquidity deficit expected to continue, and how might it affect fixed deposit rates in the near future?
While the liquidity deficit has narrowed slightly in recent days, analysts anticipate continued pressure on short-term interest rates. The expectation is that January-March may see an improvement in liquidity, possibly easing the need for further rate hikes. However, if the Reserve Bank of India (RBI) chooses to sterilize liquidity, fixed deposit rates could see an increase in February-March.
How do experts view the trajectory of fixed deposit rates for longer holdings?
For longer-term fixed deposits, experts suggest that any rate increases are unlikely to exceed 20 basis points. This cautious approach is influenced by the belief that policy rates have peaked, and rates could be on the horizon in 2024-25. Despite expectations of moderate credit growth, banks are likely to continue to prefer shorter term deposits to manage liquidity.
What factors influence the focus on shorter-term deposits, and how could credit growth affect this strategy?
The Reserve Bank of India’s forward rates continue to shape the financial landscape. While there is an anticipation of a future tax reduction, most experts expect it in the second half of 2024. Analysts suggest that short-term fixed deposits, making up a significant part of term deposits, may experience a limited impact on financial costs with incremental increases. The focus on shorter-term deposits is expected to continue, even as credit growth is projected to moderate.
Has the rise in fixed deposit rates peaked?
Yes, experts suggest that fixed deposit rates have largely peaked. While specific banks may make small increases for particular holdings, the overall trend is expected to stabilize. Once the repo rate begins to decline, fixed deposit rates are likely to fall, albeit gradually.
What should investors consider while choosing fixed deposits in the current scenario?
It is recommended that investors lock in the current peak rates, especially in the one- to two-year term, as most banks offer their best rates in this range. Longer tenures generally provide higher returns, but it is important to consider liquidity requirements. It is recommended to avoid investments in fixed deposits with durations exceeding two to three years, as longer term commitments may not be as beneficial as other investment options.
What are some alternatives to traditional bank fixed deposits?
Investors can explore alternatives like Small Finance Banks (SFBs), which currently offer competitive FD rates of 8% and above. However, it is essential to diversify and avoid high exposure to SFBs, given their relatively young status. Corporate fixed deposits and corporate bonds are other options that might offer higher returns, but come with different risk considerations. Additionally, debt mutual funds (MFs) provide diversification and can offer capital gains when interest rates fall. However, it is important to note that debt MFs do not guarantee predictable returns.
Are there any risks associated with alternative fixed deposit options?
While alternative options like SFBs, corporate FDs and corporate bonds offer higher returns, they also come with their own set of risks. For example, corporate FDs are not covered by Deposit Insurance, and Credit Guarantee Corporation (DICGC) insurance, and the risk of a company’s finances will deteriorate with time. Investors should carefully assess the credit rating of non-banking finance companies (NBFCs) offering corporate FDs. Diversification and understanding the risk-return profile of each option is crucial to making informed investment decisions.