The central bank and the Reserve Bank of India Are the two governing bodies that are responsible for formulating monetary policies and controlling India’s financial system. One of the key tools that they have at their disposal is the interest rate, a tool that has a significant impact on the economy.
The Reserve Bank of India has revised their policies for fixed deposit interest rates. This article gives short notes on those changes and how they have affected the economy at large.
Understanding fixed deposits in India
Firstly, let us briefly explain what FDs are. FDs are a type of savings account in which an individual deposits a certain amount of money for a fixed period, usually from 1 month to 10 years. The interest rate on the FD is predetermined and remains fixed for the entire period of the deposit. Upon maturity, the depositor receives the principal amount plus the accumulated interest.
Changes made to the repo rate
To begin with, the most recent change that the RBI made to their policy was primarily focused on the repo rate; this is the rate that they levy when the RBI lends money to banks. Earlier in June 2020, the Reserve Bank of India had reduced the repo rate by 40 basis points, from 4.40% to 4.00%.
This revision was done to provide more liquidity banking systems and facilitate higher volumes of lending and borrowing. Reduced fixed deposit interest rates make for cheaper borrowing that can stimulate economic growth by triggering consumer spending and business investments.
How the repo rate impacts the banks’ lending capabilities
However, lower interest rates also mean lower returns for savers. Banks can use the repo rate as a benchmark for determining their own lending and deposit rates. When the repo rate is reduced, banks can also reduce their lending and deposit rates too.
This is because they are able to borrow money at a cheaper rate from the RBI and can therefore afford to lend money at a lower rate. Similarly, when the RBI reduces the repo rate, it also reduces the interest rate it pays on its own fixed deposits. This, in turn, puts downward pressure on the interest rates offered by other banks.
Introducing the Marginal Cost of Funds Lending Rate
The introduction of the Marginal Cost of Funds Lending Rate in 206 also affected the interest rates significantly. Known as the MCLR, It is a methodology for determining the final lending rates for banks.
Under this particular system, the banks calculate lending rates by considering their marginal cost of funds. In short,the marginal cost of funds is the cost of borrowing money at the prevailing interest rates. The MCLR Is designed to make lending rates more responsive to market conditions.
Effect of the MCLR on bank’s activities
Since the introduction of the MCLR system, the interest rates on FDs have become more dynamic. Banks can adjust their FD interest rates based on changes in the market interest rates. This has resulted in fixed deposit interest rates being linked to the repo rate and other market rates that are subject to fluctuations.
As a result, the FD interest rate is no longer fixed for the entire deposit period but can change during the deposit term. This is why consumers are advised to use a fixed deposit calculator to determine their FD payout before, during and after the stipulated tenure.
Introduction of the Targeted Long-Term Repo Operations
The third change that the RBI implemented in October 2020 is the new liquidity measure called the Targeted Long Term Repo Operations. This is a scheme by which the RBI provides long-term funding to banks at a fixed rate. It is supposed to encourage banks to increase their lending rates to certain sectors of the economy, such as small and medium-sized enterprises.
Impact of the TLTRO on Banks
The TLTRO scheme did result in a mixed impact on interest rates for fixed deposits. It increased the availability of funds for banks resulting in offering higher FD interest rates. The other result was that it limited the bank’s capabilities to offer higher fixed deposit interest rates.
Considered the safest type of investment, fixed deposits in a reputed financial institution such as Bajaj Finserv offer the opportunity to earn income between 6% and 8% on deposits. Additionally, according to Section 80C of the Income Tax Act, individuals may be eligible for tax deductions on their deposits.
In case you are unfamiliar with calculating FD interest, you may utilize an FD calculator. However, compared to strategies such as debt funds, the slightly lower returns on FDs may be less appealing to investors.