Floating rate fixed deposits, as the name suggests, are a variant of fixed deposits which offer variable interest rates for the entire tenor of the deposit. Also known as floating rate term deposits, this category of FDs offer dynamic returns in accordance with a reference rate, which is periodically reviewed.
The interest rate offered on these instruments is floating and is not pre-decided as in the case of normal fixed deposits. This helps the investors to make money in a rising market or with positive macroeconomic conditions.
Floating rate fixed deposits could be a suitable option for those investors who keep a watch on the macroeconomic conditions, which may affect future interest rates.
In floating rate FDs, the interest rate is linked to an external benchmark – usually the repo rate. Repo rate is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks. Repo rate is reviewed by the RBI’s Monetary Policy Committee periodically and it is used to control liquidity in the market. As of December 2023, India’s repo rate stood at 6.5%.
The other commonly used benchmark rate for floating rate fixed deposits is the 91-Day Treasury Bill rate.
How does floating rate FDs work?
The rate of interest of a floating rate fixed deposit consists of two components, benchmark rate and mark-up. The final rate is derived by adding the benchmark rate and the applicable mark-up.
The interest rate on floating rate fixed deposits would be changed whenever there is a change in the benchmark rate during the tenor of the deposit. The banks, however, cannot revise the mark-up during this period.
The rates are reviewed either monthly or every 3 months, which may vary from bank to bank. An alert is usually sent to customers on every effective change in interest rate.
The interest payout for a floating rate FD generally takes place on the last day of every quarter.
Benefits of floating rate fixed deposits
These kinds of deposits allow you to take advantage of interest rate changes without closing and re-booking your fixed deposits.
So, in a scenario of rising interest rates, your floating rate FD would have automatically fetched a higher rate of interest than what you would have gained compared to a traditional fixed deposit.
These deposits also protect your investment from the effect of inflation by adjusting to the prevailing interest rates.
Besides that, most banks also offer the facility of loan/overdraft against floating rate fixed deposits. Senior citizens usually enjoy special benefits of a higher interest rate of 50 basis points compared with general customers.
Floating rate FDs vs traditional FDs?
It may not be advisable to always choose floating rate fixed deposits over traditional FDs. As these products offer dynamic returns, they can prove to be a wrong bet if you lock your money in these instruments in a scenario where interest rates are expected to fall.
Such instruments should only be chosen after taking into account the prevailing macroeconomic situation, as they can result in significantly lower returns.