Consider moving funds to floating rate fixed deposit from regular fixed deposit

NEW DELHI: Recently private sector bank Yes Bank introduced an interesting new instrument called the floating rate Fixed Deposit (FD). The rate on this deposit will be linked to RBI’s repo rate which is currently at 4.9%.
The bank is offering a mark-up of 1.10% on this 4.9% rate for a 1-1.5 year FD (taking total interest rate to 6%). For 1.5-3 years the bank is offering a mark up of 1.6% over the repo rate of 4.9% taking the total interest rate to 6.5%.Mark-up rate is the additional rate of interest offered over and above a base rate which is the repo rate here.
What makes this instrument attractive right now is that in the near term interest rates are likely to remain high (with inflation being on an upward trajectory), so the interest rates of a floating rate deposit will also move up. Repo rate is the rate at which RBI lends money to commercial banks and it is reviewed by the RBI regularly to control liquidity in the market. The RBI has hiked the repo rate twice already this fiscal (40 bps hike to 4.4 % in May and 50 bps hike to 4.9% in June) and markets expect further hikes.

Above is an illustration of how the customer can benefit by investing in a floating rate FD compared with a fixed rate FD. While the amount invested remains the same, the post tax interest earned is higher in a floating rate deposit.
Uptil now most banks in India have only offered fixed rate FDs. And most advisors have recommended ‘laddering’ to their customers in order to derive the benefit of high interest rates and liquidity.
Ravi Saraogi, a SEBI registered investment advisor and co-founder Samasthiti Advisors says that this ‘laddering’ meant that investors with say a Rs 5 lakh corpus, would keep Rs 1 lakh in a 3 month FD, another lakh in a 6 month FD and maybe another lakh into a 1 year FD. The remaining amount of Rs 2 lakh would be kept in a longer tenure 2 or 3 years FD. While the smaller amount FDs would be useful for sudden liquidity requirements, the larger amount deposits would be useful for earning higher interest rates. With this new floating rate instrument, the depositor does not have to keep track of multiple deposit amounts and the interest rates they are earning. The floating rate FD’s interest rate is automatically reset each month, depending on the repo rate which was prevailing in the previous month.
Usually, when interest rates move upwards, banks immediately hike loan rates and EMIs paid for housing loans are the first to increase as home loan rates move upwards rather quickly.
However, the same is not the case for fixed deposits as banks take their own time in offering higher rates. This makes the current offer of a floating rate FD interesting.
By and large most banks agree that interest rates will move up and that the rates on their FDs will also move up. But no one knows when this will happen. Currently, private sector bank ICICI bank is offering customers 5.35% for 1-2 year FDs and 5.5 % on 2-3 year FDs. HDFC bank is also offering similar rates on its fixed deposits. Other banks may also consider floating rate FDs, but as of now, we will have to wait and see.