Yes Bank recently announced the launch of a floating rate fixed deposit (FD). While a few others like IDBI Bank too offer floating FD rates, analysts say it is unlikely that more lenders will do so as it may affect profitability at times.
Be it for customers or banks, floating FD rates may not make sense at a time of fluctuating interest rates, according to analysts. While the customers with floating rate FDs can be in profit at a time of rising interest rates, they should be aware that their returns will come down too in a falling interest rate scenario.
What is a floating rate FD?
In floating rate FDs, the rate of interest moves in tandem with a reference rate, which is periodically reset, unlike regular FD rates where the rate of interest remains the same for the tenure. Floating FD rates can be considered a tool to manage interest rate risk, added analysts.
“Essentially, here instead of the fixed deposits carrying a fixed rate for the tenor of the deposit, the interest rate is benchmarked to a reference rate and then a mark-up/spread is available on top of that. Further, the periodicity of resets is also specified in the terms,” said Karan Gupta, analyst and director, India Ratings and Research.
Floating rate FDs also mean variable returns. “The interest rate on floating FDs is linked to an external benchmark and depending on the movement of the benchmark, the interest rates on deposits can increase or decline. A rising benchmark like the repo rate will mean higher interest rates and return to depositors,” said Aashay Choksey, assistant vice-president, financial sector ratings, ICRA.
Impact on banks
Floating rate FDs are likely to be popular in a rising rate environment, but banks need to take into consideration various other parameters to protect their profitability.
“Banks have floating rates on the loans and asset side. If the banks have fixed rates on the FDs, if the interest rate moves down in an environment of falling interest rates, then their interest rate will keep coming down on the loan but on the deposit side it will remain steady as it is it is a fixed rate. Then their profitability will come down. Thus, in a falling interest rate scenario, having fixed FD rates will have a negative impact on banks,” said Krishnan Sitaraman, analyst, Crisil.
So when interest rates are rising, banks have better profitability with fixed rates on FD and in a falling interest rate scenario, it is the reverse. But with floating FD rates, the profitability will be by and large similar for banks, said analysts. Given this, experts feel that it is unlikely many banks will introduce floating rate FDs for all customers soon. “I don’t think that this will become a significant share of bank term deposits anytime soon as while it is beneficial to depositors in a rising interest rate environment, the same will also impact negatively once the interest rate cycle turns. For banks also, matching the asset and liability profile could pose a challenge,” said Gupta.
Some banks are still opting for floating rate FDs to retain customers. “For banks, a longer-tenor deposit is beneficial for their asset-liability matching. This apart, lower premature withdrawals also improve their deposit renewal rates and, hence, are beneficial for customer retention,” added Choksey.
Customers need to keep caveats in mind
While customers benefit from rising rates in floating FDs, they should be mindful of the external benchmark not moving in line with expectations or the market movements, according to analysts.
“There may be an immediate repricing in an upward interest rate environment but it will turn unfavourable as the interest rate cycle turns,” said Gupta.
“The money market yields started moving up much earlier than repo rates and hence the repricing of floating rate deposits may be with a lag to broader market movements or other benchmarks. Hence, a transparently determined benchmark for floating rate deposits is important while opting for floating rate FDs,” said Choksey.
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