Should you Invest in Floating Rate FD (Fixed Deposits) 2022?

A typical fixed deposit (FD) will offer a fixed interest rate for the entire tenure of the deposit. But in a Floating Rate FD (2022) or Floating Rate Fixed Deposit in India, the interest rates will change dynamically and rise and fall in line with the RBI repo rate.

Is floating rate FD fixed deposit a good option to invest in?

We discuss this here in detail.

What is a Floating Rate FD?

A floating rate FD, as the name suggests, has an interest rate that changes based on external benchmarks (RBI Repo Rates).

The interest rate of a floating FD will consist of 2 components – benchmark rate (i.e. repo rate) and the mark-up. The final rate is derived by adding the repo rate and the applicable mark-up. Once a deposit is made, the mark-up remains constant throughout the tenure of the FD. But since the repo rate changes, the overall interest rate will be dynamic and change based on changes announced by RBI in Repo rates.

As repo rates increase (in a rising rate cycle), the depositors will get higher returns from the rise in interest rates of their existing floating rate FDs. And this facility allows the depositors to take advantage of interest rate hikes without closing and re-booking their fixed deposits.

When Floating Rate FDs Work Best?

Floating-rate fixed deposits work best in a rising rate scenario.

The RBI has made its stance very clear that rate hikes are a certainty in the short term (2022 and 2023). So as of now, these dynamic rate deposits that link FD rates to a rising benchmark (Repo Rate) will do well as the depositors gain from the rising returns from their dynamic FDs. One can benefit from interest rate hikes without having to break existing deposits.

Also read – When will FD rates Increase?

A big disadvantage of regular bank fixed deposit (FD) is that any subsequent interest rate hikes do not benefit existing FD holders. Whenever RBI has raised policy rates in past, the banks are quick to increase loan rates but are extremely slow in passing on the benefit of rate hikes to depositors (FD). Now with a floating rate FD and being pegged to a dynamic external repo rate, there will be a lot more transparency in the FD interest rates.

So the new floating rate fixed deposits do address a shortcoming of the traditional fixed deposits.

But it works well in a rising-rate environment, it becomes highly unrewarding in a falling rate environment. Suppose you book an FD when the Repo rate is 4% and the mark-up rate is 1%. So you get an FD at 4+1=5%. Now if repo rates are cut to 3%, your floating rate will reduce to 3+1=4% only.

So no one will want to be in a floating rate FD in a falling rate scenario. Isn’t it?

Related Reading – My quote in Mint about floating rate FDs

But getting the highest FD interest rate should not be the only factor when choosing a bank to park your FDs in. If the amount in FDs is large (much higher than DICGC’s cover of Rs 5 lakh), then one should also assess the financial health and stability of the bank itself and not just go after the highest or increasing rates. For large deposits where safety is paramount, one can look at spreading deposits majorly across the safest banks of India or the systematically important banks.

In general, and at least in the rising interest rate environment, the penalty for premature closure of floating rate FDs will be high. So in case, there is a probability of premature withdrawal from your FD, then go for traditional fixed-rate FDs and not the floating rate FDs as they have higher penalty charges.

Banks have offered similar products earlier too like the Floating Rate Bulk Term Deposit (FRBTD) or similar ones. But what is new now, in my view, will become a norm soon in the Indian banking space. Other banks too will introduce floating rate FD schemes as well.

So very soon, you will see floating-rate fixed deposits from not only the major banks like Floating Rate FD HDFC, Floating Rate FD SBI and Floating Rate FD ICICI, but also from other and smaller banks like floating FD Bank of Baroda, floating FD Bank of India, floating FD Canara Bank, floating FD Central Bank of India, floating FD Punjab National Bank, floating FD State Bank of India, floating FD Axis Bank, floating FD Kotak Mahindra Bank, floating FD IndusInd Bank, floating FD IDBI Bank, floating FD IDFC First Bank, floating FD Bandhan Bank, etc.

Fixed Deposit Strategy (2022)

Here is what your Fixed Deposit Strategy Should be –

  • When you anticipate interest rate hikes in the coming 1-2 years, then switch to floating rate FDs.
  • As the rate hike cycle nears its end, its time to move to regular fixed deposits and lock in the (already) high rates for the long durations
  • Easier said than done, but if you are fond of FDs, then this is what needs to be attempted. And if you have doubts about interest rate movements, then keep it simple and stick to your regular fixed deposits where interest rates remain stable and don’t change. And if you want to move out of FDs, then you can also look at good debt funds which are good alternatives to fixed deposits and offer much better post-tax returns.

I hope now you know exactly what is a floating rate fixed deposit (FD) in India 2022 and whether you should invest in floating rate FD or not?

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