Why fixed deposits are a good choice?

FD (Fixed deposits) are the safest and simplest form of financial instruments. The interest rate on fixed deposits are higher than that offered on savings account. Some banks offer loans against Fixed Deposit Certificates at competitive interest rate. Some banks also offer credit card with the credit limit up to the amount of the fixed deposit amount. Fixed deposits are permitted for up to 10 years only. The longer the term period, higher is the interest rate provided the repo rates don’t fall. The companies nowadays offer company fixed deposits. But these are not regulated by the RBI.

Company Fixed Deposits are deposits placed by investors with companies for a fixed period of time at an agreed rate of interest. The Financial Institutions and Non-Banking Finance Companies accept the Company Fixed Deposits. They are mobilised by the government under the Section 58A. They are unsecured deposits and therefore if the company defaults, the investor cannot sell the documents to recover the capital. Thus making it a risky investment decision. Company fixed deposits are provided when the companies need cash flow but cannot issue shares, they offer fixed deposits at profitable rates. 

The yield on your deposits vary from individual to individual. You can earn higher interest than that of your colleague as u are in a higher tax bracket and the investment returns are less. You need to optimise the fixed deposits’ utilisation. It can be done through building an emergency fund by opening a fixed deposit account. The money kept aside for emergencies can also earn returns. When a person is setting up new investment base, it is advised that he open a deposit account rather than taking credit. The fixed deposit will appreciate his income potential. By investing in deposits, the individual is ensuring that he has a safety cushion of money to back him up.

When you are investing do not end up investing in high risk investments such as moving investments in equity sector, commodities or even real estate for that matter. You can instead even it out with investing in bank or company fixed deposits. If you wish to save taxes, then you can invest for fixed deposits in your parent’s names as long as they don’t have taxable income. The interest earned on the fixed deposit is tax-free for up to Rs.2 lakhs and up to Rs.2.5 lakhs if they are senior citizens. Senior citizens also earn 0.25% to 0.5% additional interest on the fixed deposits. You can also invest in your eldest child’s name and save interest up to Rs.2 lakhs as it is tax-free.

Fixed deposits also play an important role in the consolidation of investments when you approach retirement. When you are retired, you don’t really have a fixed source of income other than pension. That is when fixed deposits play a pivotal role. You can invest in fixed deposits for different tenure to meet you various financial needs in the future.

But, be very careful when you choose the bank to invest your fixed deposits in as the small co-operative banks may not be able to secure your money at the time of bankruptcy. The rule is that the bank must secure each investors for up to Rs.1 lakh per investor per bank. But, the company fixed deposits do not have any assurance as they are not regulated by the Reserve Bank of India. Keep in mind that the company fixed deposit are unsecure and you have no collateral. But since the risk is higher, the interest rate is also higher. Exercise caution before investing.

Effect of RBI Rate Cut on Indian Banks in the Short Term

After the recent rate cut of 25 basis points (bps) by the Reserve Bank of India (RBI), banks may find it difficult to cut their lending rates over the short term, according to Pradeep Kumar, Managing Director of the State Bank of India (SBI).

The rate cuts from RBI were initiated after a prolonged period of inflation control by the apex bank. Going ahead in the same direction, Mr Raghuram Rajan, the present Governor of RBI, may cut rates by a further 50 basis points in the current calendar year.

 According to Mr Kumar, SBI and other major banks had already anticipated such rate cuts, and accordingly reduced their deposit rates long before the rate cut was officially announced by the RBI. Also anticipating future falls in rates, customers have been shifting to fixed deposits from their savings deposits so as to ensure steady flow of interests.

In such a scenario, banks like SBI have found it difficult to get their cost of funds to decrease in spite of the lowering of deposit rates. In fact, during the last financial quarter, SBI reported a rise of 1 basis point in their cost of funds. As such, initiating rate cuts in the short term may prove difficult for banks. However, if the inflationary and rate cut trends continue, then all banking institutions will have to relook their rates.

As of now, only United Bank and Union Bank have decreased the base rates since RBI’s repo rate cut in January. The State Bank of India, however, had reduced deposit rates in July last year by around 25 to 50 bps in selected categories. There being a tilt in credit demand as well as availability of excess funds, have inspired some banks to cut deposit rates over the last two financial quarters.

The credit demand, according to Mr Kumar, hasn’t seen change in the ground level. And in absence of new policies that create new assets and large projects, there cannot be improvements in credit demand. Weak demand has also caused large banks to post flat growth figures in the corporate credit sector. ICICI bank, for instance, posted flat figures of 4% year-on-year growth in December.

Mr Kumar has also commended SBI for its system of stress recognition, which helps in identifying Non Performing Assets (NPAs) when a related event happens. SBI currently has one of the lowest restructured assets and NPAs among public sector banks in India. This indicates a high level of identification of NPAs very early in their tenures.

Conclusion

●     The falling rates of interest are instigating customers to move to fixed deposits from their savings deposits, thereby keeping the cost of funds constant for banking institutions. This has kept banks from reducing rates further.

●     If there are more rate cuts by RBI in future, then banks are likely to reduce their rates also.

What is CASA ratio and how does it affect fixed deposits?

With the Reserve Bank of India recently announcing a cut in the repo rate, the base rate for many banks have changed and soon to follow suit are loan rates as well as deposit rates. Understanding the interdependence of all these factors is the primary goal of this write-up. Let’s go by defining each of these terms before looking into how they are linked to each other.

What is CASA ratio? 

CASA ratio is defined as the ratio of Current and Savings Account deposits to the overall deposits of a bank. This ratio is an important financial figure for any bank as it depicts a lot of other relevant information that drives major bank-specific decisions. CASA ratio is not a value that has any regulation directives related to it. Nonetheless, it is a significant value for all banking entities. A higher CASA ratio for a bank means the deposits with current and savings are more as against the total deposits of the bank

Effect of CASA ratio on fixed deposit rates

Since the interest rate offered by banks on current account deposits is nil and that offered on savings account is very low, one of the ways for banks to improve its profit margin is to increase the deposits in current and savings accounts which in turn signifies a higher CASA ratio. But, since CASA is a ratio, in order to increase profits, while deposits with bank (current and saving) should be increased, the cost of term deposits should be decreased. This happens when the rates offered on term deposits are lowered to match the required CASA ratio.

Let us take an example. Suppose a bank offers savings account deposits an interest rate of 4% while the same bank offers an interest of 8% on fixed deposit of one year. In case this bank has a lower CASA ratio, means the deposits with the bank are low, in such a scenario, the bank may increase the interest rate offered on savings so as to encourage people to deposit more. This surplus cash can then be circulated by the bank and lent forward to gain more profit.

Ways in which banks increase their CASA deposits

Since a greater CASA is beneficial, banks have been employing several innovative techniques to increase their CASA value. Some of the recent tactics employed by banks to raise their savings plus current account deposits are listed as under –

·         Most banks have launched special saving deposit mobilization programs

·         Some banks have bundled up their savings account with insurance benefits for customers to get attracted to it

·         Others have tied up with various insurance companies to offer specific insurance products coupled with savings accounts. For example, Central Bank of India has partnered with Cholamandalam Insurance to offer free accident insurance with every savings deposit account

·         There are plans in progress to offer some minimum rate of interest on current accounts also in order to attract more current account deposits

·         Bigger banks are trying to merge with smaller banks with high casa ratio. For instance, in a strategic move, ICICI merged with Bank of Rajasthan which had a high CASA value