Table of Contents
- What Factors Influence FD Interest Rates in India
- How the Repo Rate Influences FD Rates
- How the Demand for Loans Influences FD Rates
- Why FD Rates are High in 2024
- Repo rate is at its Highest Level Since April 2016
- Credit Deposit Ratio is at its Highest Level Since 2005
- How to interpret the CD ratio?
- Why FD Rates are Likely To Stay High For a While
Do not index
Do not index
FD rates have been depressed for the majority of the last 8-10 years.
This trend resulted in investors staying away from the once go-to investment-cum-savings product and investing in riskier assets like stocks and equity mutual funds to beat inflation.
But we are in 2024 and it seems FDs rates have made a comeback. With a vengeance!
It is quite easy to find FDs from reputed banks and NBFCs that offer 7-8.5% interest rates.
In this article, we discuss:
Good news: There’s probably even some headroom for FD rates to go higher. We discuss this too.
What Factors Influence FD Interest Rates in India
Before looking at why FD rates are high today, it is imperative that we understand what factors influence FD rates. These factors are in play today and will always be the most relevant even in the future as far as FD rates are concerned.
Factor 1 ➡️ The Repo Rate
Factor 2 ➡️ Demand for Loans
Let’s look at each individually.
How the Repo Rate Influences FD Rates
Think of repo rate as the benchmark interest rate of the economy. When the repo rate goes up, all interest rates in the economy go up.
By all, we mean absolutely all interest rates - FD rates, home loan rates, PPF rates, car loan rates, NPS rates, personal loan rates etc. So, the repo rate affects savers (people who save money in FDs, PPF, bonds etc.) as well as borrowers (people who take home, car and personal loans).
Now, the next logical question is: Who sets the repo rate and on what basis?
Quick answer: The RBI sets the repo rate to achieve two things: support economic growth and keep inflation as close as possible to the 4% mark.
Long answer: How does the RBI use repo rate to support growth and control inflation? (article coming soon!)
How the Demand for Loans Influences FD Rates
Banks and NBFCs (Non-Banking Financial Companies) are in the business of lending or giving loans to people and corporates.
But they can’t function without savers who deposit money in their savings and fixed deposit accounts.
Here’s a simple representation of how banks collect deposits from savers and give it to borrowers:
Now, consider a scenario where the demand for loans is so high that the deposits with the bank are insufficient to make these loans.
To attract more deposits, the bank simply increases its interest rates making it more attractive for savers to deposit money with the bank.
This is exactly the scenario in 2024 and is further discussed in the second half of the next section.
Why FD Rates are High in 2024
Simply put, both the critical factors that influence FD rates are positioned for FD rates to be high.
Repo rate is at its Highest Level Since April 2016
We saw how repo rate is the benchmark rate of the economy.
To control inflation and take away economic support that was no longer needed, the RBI started raising the repo rate in May 2022 all the way up to Feb 2023.
This rise in repo rate meant all the interest rates in the economy went up.
First, interest rates on loans went up. Soon after, interest rates on government schemes like PPF as well as bank FD rates went up.
Since Feb 2023, the repo rate has been held constant at 6.5%. While nothing is certain about the future, it is widely believed that the repo rate has peaked and will be held at the present levels for a few more months.
Credit Deposit Ratio is at its Highest Level Since 2005
We saw that banks accept deposits and make loans using these deposits. Loans are also referred to as ‘credit’ in the banking industry.
Now, there’s an interesting metric that the RBI has been publishing since 2005 called the credit-deposit ratio or the CD ratio. Let’s understand this with an example.
Say CD ratio is 50 - This means for every Rs. 100 deposited with banks, Rs. 50 is disbursed as loans. But how to interpret this?
How to interpret the CD ratio?
A very low CD ratio indicates that the banks are not utilising their deposits optimally to disburse loans. This is bad for bank profitability.
Banks are in the business of lending. They make revenue from the interest they collect from the loans they make. So, banks ideally want to use maximum deposits to make maximum loans.
On the other hand, a very high CD ratio indicates that demand for loan is very high compared to the deposits available with the banks.
When the CD ratio is very high, banks are giving many loans relative to the limited deposits they have. However, making incremental loans becomes difficult if the deposits don’t keep up pace with the demand for loans.
This is exactly what happened in FY24 and continues to happen. The CD ratio reading for FY24 stood at 80% - the highest since RBI started publishing the metric in 2005.
Note: The RBI doesn’t stipulate or recommend an ideal CD ratio as that may lead to low profitability for banks or reckless lending.
Why FD Rates are Likely To Stay High For a While
As we discussed, two conditions have led to high FD rates in 2024:
- High repo rate
- High demand for loans
Let’s talk about the outlook of the repo rate first.
Repo rate, as we saw, is set by the RBI to promote growth and keep inflation close to the 4% mark.
Today, economic growth is robust in India. We are the fastest growing large economy and expected to retain the title for many years to come. There are no visible headwinds that can challenge India’s growth trajectory.
So, the RBI doesn’t really have to step in to lower interest rates and promote economic growth today.
However, when it comes to inflation, while the RBI has managed to get it down from the 6-7% range in 2023 to the 5-6% range in 2024, it is still not at the sweet spot of 4%.
So, the RBI may continue to keep the repo rate at the present levels until the inflation hits the 4% mark or until the economy requires monetary support. Both of these events are not on the horizon.
Now, let’s talk about the outlook of the demand for loans.
As we saw, credit-deposit ratio (CD ratio) posted its highest level of ~80% in FY24 since 2005.
The CD ratio is not expect to cool down as the demand for loans is expected to stay strong over FY25. CareEdge has estimated that the CD ratio will increase slightly to 81% in FY25.
As long as the CD ratio continues to stay close to the 80% mark, banks will keep FD rates high (or even increase them!) to compete with each other for your deposits.
Happy Investing!
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