To quell the sky-high inflation, RBI’s Monetary Policy Committee has sat down for a meeting four times this year, and the result was a repo rate hike of 190 basis points. With the increasing repo rate, two crucial things have changed. Firstly, loans have become costlier, and FDs have become more lucrative. Hence, banks have developed floating-rate FDs to attract depositors to park their money in FDs.
What’s Happening?
Central banks across the world are hustling to tame inflation. Hence, there are constant rate hikes. As depositors, we always seek to earn the highest interest rate possible. Therefore, most of us are waiting for the interest rates to peak so we can park our funds in an FD. To eliminate this drawback, most banks have introduced floating rate FD.
What is a Floating Rate FD?
Floating rate FD is similar to a traditional fixed deposit, but the only difference is how it treats interest rates. In a traditional FD, your FD will not affect rising and falling repo rates. But, in a floating rate FD, if the repo rate increases, your FD will earn higher interest & if the repo rate decreases, your FD will earn less interest.
Working of Floating Rate FD
For example, you make a floating rate FD for three years of Rs 1,00,000. With the current repo rate of 5.90% and markup of 1% offered by your bank. You will get an interest rate of 6.90%. If, after some time, the repo rate gets revised to 6.4%, the same FD will earn a return of 7.4% per annum. But your FD rates will also fall if RBI cuts the repo rate.
What is Markup Rate?
It is the additional interest rate offered by the bank over and above the benchmark (repo rate).
Yes Bank first introduced the concept of floating rate FD. Later, Axis Bank, SBI, IDBI Bank, Indian Bank, Bank of India, Bank of Baroda, Union Bank, and Indian Overseas Bank joined the paths.
Drawbacks of Floating Rate FD
- For a traditional FD, the minimum deposit amount varies from Rs 1,000 to Rs 5,000. But, to open a floating rate FD the minimum deposit threshold is Rs 10,000.
- The tenure of a traditional FD ranges from 7 days to 10 years. But, the tenure of a floating rate FD is one year to less than three years.
- The penalty for premature withdrawal is higher than traditional FD.
- Most floating rate FD comes with only reinvestment options.
What Must Depositors Do?
If you are someone who is waiting for the repo rates to peak, floating rate FD can be your way to go. As and when the repo rate changes, your FD rates will revise. But read the terms and conditions beforehand because the premature withdrawal penalty is high.
Another alternative is opting for the laddering FD technique. Under this strategy, you diversify a huge chunk of money into various FDs of different tenures. By doing so, the interest rate can be averaged as they rise, and the opportunity cost can be minimised. Moreover, if you need money, you will have an FD close to maturity.
That’s it for today.
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