Explainer: Have bank fixed deposit rates peaked and how should investors play it?

Several banks have raised fixed deposit rates to meet the year-end demand for credit. In this explainer, we delve into the reasons behind the recent surge in fixed deposit rates by several banks, whether this increase has reached its peak, and what alternatives investors might consider in the current financial landscape. As interest rates evolve and financial institutions adapt, staying informed about the various options and associated risks becomes paramount for making sound investment decisions.

Why have several banks, including State Bank of India, Bank of Baroda, and Kotak Mahindra Bank, raised their fixed deposit rates?

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The increase in banks' fixed deposit rates has been relatively slower compared to the rise in the repo rate. Banks are aiming to make their deposit rates more attractive to attract additional deposits, especially with the Reserve Bank of India (RBI) increasing the provisioning requirement on unsecured loans. This move helps banks manage their assets and liabilities better.

Why have banks raised rates, particularly for shorter tenures?

Analysts attribute the recent surge in fixed deposit rates to address the demand for credit, primarily driven by the prevailing high liquidity deficit in the banking system. Banks, grappling with tight liquidity conditions, have adjusted rates for shorter tenures to attract more deposits and manage their liquidity.

Is the liquidity deficit expected to persist, and how might it impact fixed deposit rates in the near future?

While the liquidity deficit has slightly eased in recent days, analysts anticipate continued pressure on short-term interest rates. The expectation is that January-March might see an improvement in liquidity, potentially mitigating the need for further rate hikes. However, if the Reserve Bank of India (RBI) opts to sterilize liquidity, fixed deposit rates could see an increase in February-March.

How do experts view the trajectory of fixed deposit rates for longer tenures?

For longer-tenure fixed deposits, experts suggest that any rate increases are unlikely to exceed 20 basis points. This cautious approach is influenced by the belief that policy rates have peaked, and rate cuts could be on the horizon in 2024-25. Despite expectations of credit growth moderating, banks are likely to continue favouring shorter-term deposits to manage liquidity conditions.

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What factors are influencing the focus on shorter-term deposits, and how might credit growth impact this strategy?

The Reserve Bank of India's previous rate hikes continue to shape the financial landscape. While there's anticipation of a future rate cut, most experts expect it in the second half of 2024. Analysts suggest that short-term fixed deposits, constituting a significant portion of term deposits, may experience limited impact on funding costs with incremental hikes. The focus on shorter-term deposits is expected to persist, even as credit growth is projected to moderate.

Has the increase in fixed deposit rates peaked?

Yes, experts suggest that fixed deposit rates have largely peaked. While specific banks may undertake small hikes for particular tenures, the overall trend is expected to stabilise. Once the repo rate begins to decline, fixed deposit rates are likely to fall, albeit gradually.

What should investors consider when opting for fixed deposits in the current scenario?

It is advisable for investors to lock in at the current peak rates, especially in the one- to two-year tenure, as most banks offer their best rates in this range. Longer tenures generally provide higher returns, but it's crucial to consider liquidity requirements. Avoiding investments in fixed deposits with tenures exceeding two to three years is recommended, as longer-term commitments might not be as beneficial as other investment options.

What are some alternatives to traditional bank fixed deposits?

Investors can explore alternatives such as Small Finance Banks (SFBs), which are currently offering competitive FD rates of 8% and above. However, it's essential to diversify and avoid high exposure to SFBs, considering their relatively young status. Corporate fixed deposits and corporate bonds are other options that might offer higher returns but come with different risk considerations. Additionally, debt mutual funds (MFs) provide diversification and can offer capital gains when interest rates decline. However, it's important to note that debt MFs don't guarantee predictable returns.

Are there any risks associated with alternative fixed deposit options?

While alternative options like SFBs, corporate FDs, and corporate bonds offer higher returns, they also come with their own set of risks. For example, corporate FDs are not covered by Deposit Insurance, and Credit Guarantee Corporation (DICGC) insurance, and the risk of a company's financials deteriorating increases with time. Investors should carefully assess the credit rating of non-banking financial companies (NBFCs) offering corporate FDs. Diversification and understanding the risk-return profile of each option are crucial for making informed investment decisions.