The ABC of floating rate FDs
2 min read 22 Jun 2022, 11:04 PM ISTIn the current environment of rising interest rates, a floating rate FD is a good option
PremiumInterest rates are on the rise and investors who want to take advantage of this can consider looking at floating rate fixed deposits (FDs). Interest rates on floating rate FDs are dynamic and are changed based on the reference rate of an external benchmark they are linked to.
For instance, on Tuesday, Yes Bank launched a floating rate FD that is linked to the repo rate, so every time the repo rate sees a change, it will impact the interest offered on the deposit.
Currently, the repo rate stands at 4.9%, after seeing a total hike of 90 basis points in the last two months. Treasury bills is another benchmark that FDs are typically linked to.
What’s on offer
Interest rate of a floating rate FD is made up of the reference rate of the external benchmark and the spread or mark-up that the bank offers over and above the base rate. The spread is set when the FD is issued and does not change during the tenure of the FD for existing customers. However, if the bank changes its spread, it will reflect when you choose to renew an FD after its maturity.
The reference rate remains dynamic and influences the interest rate on the FD.
Interest rates on IDBI bank floating rate term deposits, or FDs, are linked to average yield at 91-Days Treasury Bills auctions during the immediately preceding three months undertaken by the Reserve Bank of India. For instance, the average yield of 91 days T-Bills during auctions held between 1 January and 30 March stood at 3.74% and is taken as the reference rate for FDs issued between 1 April and 30 June.
Punjab National Bank offers interest rates ranging from 5.2% to 5.6% on FDs with tenures o f 2, 3, 5, 7 and 10 years, but Mint couldn’t ascertain the spread on these rates and which benchmark the FDs are linked to.
Should you buy
Joydeep Sen, an independent debt market analyst, said in the current environment of rising interest rates, a floating rate FD is a good option.
“Rates will go up over the next one year, but may pause after that. Retail investors fail to keep track when the cycle will change. So, such investors can lock-in for a short tenure of a few months to two years and investors who can keep track of the rate cycle can go for longer tenures."
However, investors should note that if they want to exit when the rate cycle turns downwards, premature withdrawals attract a penalty (see table). On short tenure FDs of up to a year, penalty can be as high as 2-3%.
Investors should also shop around for higher mark-ups. “The mark-up over the benchmark is an important criteria as this tells you how much returns you can expect. Apart from the mark-up, other key points to consider are the benchmark to which it is linked, the frequency of reset and the penalties of premature liquidation of the deposit," said Pankaj Bansal, CBO, BankBazaar.com.
