Is this the right time to invest in floating rate FDs to benefit from rising interest rates?

Synopsis The repo rate hikes are yet to be transmitted completely in FD rates of a good number of banks. Therefore, we are likely to witness frequent hikes in FD rates for at least few more quarters. The possibility of a significant reduction in interest rate looks highly unlikely. Floating rate FDs do appear to hold promise in such a scenario if we go by face value. But is it really so? Getty Images In a rising interest rate scenario if you book your fixed deposit (FD) now and the rate rises later, you will end up losing interest on your FD. However, nobody is sure how long the interest rates will keep rising and what could be the peak rate. If you wait too long without investing, you may lose on the current high rate on your deposits. What if an FD gives you the benefit of future rate hikes? This is what a floating rate FD does. So, is it a good time to invest in a floating rate FD? FD rates will take time to peak The unprecedented repo rate hikes by RBI within the last 8 months by overall 2.25% has changed the fixed deposit landscape completely. The possibility of future rate hikes cannot be ruled out yet. Everyone is trying to anticipate where this will eventually peak, and which bank will give the highest interest rate especially on long term FDs. The repo rate hikes are yet to be transmitted completely in FD rates of a good number of banks. Therefore, we are likely to witness frequent hikes in FD rates for at least few more quarters. The possibility of a significant reduction in interest rate looks highly unlikely. Floating rate FDs do appear to hold promise in such a scenario if we go by face value. “FRTDs can be lucrative savings options at a time when rates are rising. They incentivise depositors to remain locked in for longer periods and garner higher returns in sync with the market,” says Pankaj Bansal, CBO, What are your floating rate FD options? There are two such FDs available from banks, one is by IDBI Bank and another one is by Yes Bank . However, the most important question is whether they are poised to give one of the best returns to their depositors. Let us understand how these FDs have performed so far and how are they likely to perform in the future. *Less than 18 months, Repo Rate + 1.1%, ** Greater than 18 months, Repo Rate + 1.6%, ^91-Day Treasury Bill + 0.5%, ^^No new deposit, 364-Day Treasury Bill + 1%, weekly data by RBI used to create a trend line to compare the direction of the different rates, actual rates may differ depending upon the averaging period and actual cut off dates, Data as on November 25, 2022; source RBI Benchmark and spread are key Floating rate FDs are typically linked to a benchmark rate and offer a fixed premium called spread above the benchmark rate. So, the deciding factor whether an FD will give higher return or not will depend upon type of benchmark and the spread. “The mark up over the benchmark, of course, is an important criterion as this tells you how much returns you can expect. Higher the benchmark, more would be your returns. Apart for the mark-up, the points to consider are the benchmark to which it is linked, the frequency of reset, and the penalties of premature liquidation of the deposit,” says Bansal. Also read: Right time to book FD or wait longer for interest rate to cross 9%? How changed benchmark of IDBI will impact FD returns The most attractive floating rate FD option from IDBI Bank was the one with its benchmark as the 364-day treasury bill and 1% spread over it. But this option was discontinued by the bank since November 1, 2018. The current rate which old depositors could be getting on this FD is close to 7.75%. However, the current option offered by the bank has the 91-day treasury bill as benchmark and has only 0.5% spread. As a result, you would get only a maximum return of around 6.63% (projected based on RBI weekly rates up to November 25, 2022) in the current scenario. Though it is much higher than the lowest rate of 6.10 offered by other banks on FD with above 1 year tenure, however, it is much lower than the maximum rate of 7.05% offered by other private banks. IDBI itself is giving its best FD rate of 7% on its special FD with tenure of 700 days. So for for FRTD of IDBI bank doesn’t appear to deliver better return in current scenario. YES Bank FRTD to give improved return but limited tenure Floating rate FDs offered by both banks are giving you an above average interest rate, however, they are not the highest. YES Bank FRTD has a slight edge as it offers a more widely followed benchmark ‘Repo Rate’ and good spread of 1.6% for long term FDs of 18 months and above. “FRTDs that are Repo-linked are also more transparent and give depositors a clear idea about how the returns on their FDs will fluctuate,” says Bansal. After the recent hike in repo rate, you can get an interest rate of 7.85% on FDs with tenure of 18 months and above, which can be considered a good rate in the current scenario as it is very close to the maximum rate of 8.05% offered by small private banks. However, it still has the limitation that the maximum tenure you can get is only 3 years. So, for longer tenure you will again have to depend upon traditional FDs. Should you go for FRTDs? Floating rate is not a one-way street. If you get the advantage of rising rate, you may be put to a disadvantage if the interest rates start falling again. Though in the current scenario the fall is appearing to be a distant thing but over the medium-term things can change. If your time horizon is medium term of up to 3 years, then going for a floating rate FD may give you the advantage of above average return during this period. However, for any period longer than this, there is the higher risk of interest rate reduction. If you are looking to book long term FDs, a good strategy would be to book traditional FDs with tenure of around six months to one year, by then the FD rates are likely to have reached close to the peak. At the time of renewal, you may go for long term FD which may give you higher return for longer period. Saturday, 10 Dec, 2022 Experience Your Economic Times Newspaper, The Digital Way! 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Published on : 2022-12-10 05:55:56

Source :economictimes_indiatimes

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