Should bank deposits be scrutinized after latest RBI interest rate hike?


The Reserve Bank of India (RBI) earlier this month raised the repo rate by 40 basis points to 4.4% and also increased the cash reserve ratio (CRR) by half a percentage point to 4.5%, effective immediately. This decision made borrowing more expensive.

By contrast, interest rates on deposits, which have been falling steadily in recent years, have risen by 25 to 50 basis points. In other words, customers will now earn more interest on their deposits. Interest rates depend on factors such as the term of the deposit, whether the bank is private or public, small or large. Old and very old people get 50 to 100 basis points more than ordinary citizens on their deposits.

Prior to the interest rate hike, the average FD rate was 5.25% per annum, which is now revised to 5.75% for general citizens. According to the previous rate, on a fixed deposit of Rs 1 lakh, clients got Rs 1,05,354 as the sum at maturity for a tenure of one year. With an additional 50 basis points, the sum at maturity after one year on a similar deposit will be Rs 1,05,875. This translates to an additional return of Rs 521.

Similarly, the deposit worth Rs 1 lakh would have turned into Rs 1,29,796 over a term of five years under the previous interest rate regime. With an additional yield of 50 basis points, the amount at maturity, after five years, will be Rs 1,33,036 – earning you additional interest income of Rs 3,240.

Have bank deposits become attractive after the rise in interest rates?

In nominal terms, interest yields have increased. In real terms, the returns are negative.

Given the current inflation rate of 6.5% and the possibility of it rising further, term deposit returns are dwarfed. Suppose with inflation at 6.5%, your deposit fixed at 5.75%. This means negative gross real returns of 0.75%. When you apply taxes according to your slab, your net real returns are worse.

As long as inflation-adjusted returns are negative, deposits cannot be attractive because they erode wealth over time. The situation could improve when inflation returns to the comfort zone of 4 to 6%, which seems difficult in the short term.

Who should consider bank deposits as investments in the current scenario?

Conservative investors

Investors who want to keep their cash balance in absolute terms can consider bank deposits. They will, however, face an erosion of wealth if their real returns are negative.

Investors who need money in the short to medium term

Customers who need funds for the foreseeable future or those who want an emergency fund can consider putting their money in bank deposits. Given the uncertainty in the stock market, it would be wise to park your emergency corpus in bank deposits to ensure the greatest security for your funds.

The elderly

Seniors, who generally have little or no appetite for risk, should consider investing in bank deposits. Since they are eligible for higher interest rates, the returns are almost at the same level as inflation. It would be like a no-win, no-loss situation for them.

Who should avoid bank deposits?

Growth-oriented investors

Clients seeking returns and wanting growth in their investments over time with a relatively high appetite for risk may not find bank deposits to be suitable investment avenues. They can consider equity-oriented investments in their portfolios.

Long term investors

Investors with a long-term approach to investments to achieve their various financial goals with a duration of more than 3-5 years may consider passing up bank deposits. Since their investment horizon is quite long, extending up to 20 years or more, regardless of their risk appetite, bank deposits may not help them. They can avoid investments in bank deposits.

What should your FD strategy be?

If you want to invest in term deposits, there are different strategies you can adopt to maximize your returns. You may consider opting for a short-term FD until interest rates rise. Once the rates go up, you can switch to FDs offering higher interest rates. Another ideal way to maximize returns is to use the ladder method. It allows you to spread your deposits across different terms and interest rates. This will help you earn more interest and your money won’t get stuck in a single rate deposit. You can reinvest them with FDs offering higher interest rates at each maturity of your deposits. Small financial banks offer higher interest rates than public and private sector banks. You may consider placing part of your funds in FDs of smaller financial banks. But before that, understand the risks involved to make a wise decision. You can also consider investing in FDs of AAA-rated companies and offering higher rates of return.

The author is the CEO of BankBazaar.com. The opinions expressed are those of the author.

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