FD investors may have to wait longer to see benefits from rate hike

In a bid to contain inflationary pressures, the Reserve Bank of India (RBI) raised the repo rate by 90 basis points (bps) in a short period to 4.9%. As a result, most banks have been quick to raise lending rates by around 40 to 90 basis points over the past month (see chart). But we still expect a significant rise in interest rates on fixed deposits (FD).

When the RBI cut the repo rate in 2020 to contain the economic impact caused by the pandemic, banks cut deposit rates to multi-year lows.

According to RBI data, the weighted average deposit rate offered by regular commercial banks in India fell by 149 basis points (one basis point equals one hundredth of a percentage point) from January 2020 to April 2022 to reach a low of 5.03%.

So why aren’t interest rates on FDs rising significantly, despite the current rise in repo rates?

Indeed, interest rates on FDs are directly linked to banks’ liquidity position and not to the repo rate, according to experts.

“Deposit rates are a function of the liquidity available to the bank and the competition between banks to attract more customers,” said Raj Khosla, founder of My Money Mantra.

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As the liquidity position of banks decreases, the requirement to obtain more funds in the form of DF increases. This is when banks typically raise deposit rates to attract new customers.

Going forward, deposit rates are expected to follow an upward trajectory.

Independent debt market analyst Joydeep Sen said “liquidity with banks has declined by around 8 trillion, at its peak, at about 3 trillion now. Bank liquidity is also expected to decline as credit drawdown increases. As attention shifts to deposits, interest rates offered on FDs will also gradually increase over the next year, but not at the same pace as repo-linked lending rates.”

Thus, FD investors may have to wait longer to see the benefits of higher interest rates. You can avoid investing in longer-term deposits now, as you may miss the opportunity to reinvest at higher rates as interest rates rise.

Deposits from small financial banks (SFBs) may also be considered as they offer interest rates 25 to 100 basis points higher than public and private sector banks. Deposits with SFBs are also covered by the Deposit Insurance and Credit Guarantee Corporation of India, under which each depositor is insured up to 5 lakh for principal and interest.

Cost of loans

Borrowers should be prepared for rising interest rates on their loans. Commenting on the impact on home loan borrowers, Adhil Shetty, CEO of BankBazaar, said “for borrowers with repo-linked home loans, the bottom will drop from 6.5% to 6.8% by 90 basis points. to 7.4%-7.7% on their next reset date, and will most likely exceed 8% in the near future New or refinancing borrowers with high eligibility (stable income, credit score above 800) can still negotiate slightly lower rates.”

If your loan is tied to the MCLR (Marginal Cost of Funds Lending Rate), the upward interest rate reset will occur on the next reset as mentioned in the loan agreement. “In a rising rate scenario, MCLR borrowers can assess whether it is cheaper to refinance to repo or to keep the same loan. We have seen that repo is cheaper in most cases,” Shetty added. .

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