Your Questions Answered: Why do fixed deposits with a 3-year tenure offer the highest rate of interest?

Q. I am a 62-year-old retired Colonel of the Indian Army, my wife is a housewife and both of my children are financially independent. I have been investing in fixed deposits all my life, I have recently noticed that the interest rate being offered on fixed deposits having a tenure of around 3 years is the highest, even higher than those fixed deposits which have a longer tenure. Can you please explain the reason behind this? What are the benefits and risks associated with fixed deposits of such tenure?

Naveen Chauhan, Jaipur, Rajasthan

Fixed deposits (FDs) are one of the most popular investment options in India. They offer a safe and secure way to invest your money for a fixed period of time and earn a guaranteed return. The interest rates offered on FDs vary depending on the tenure of the deposit and the bank.

In India, fixed deposits with a tenure of around 3 years typically offer the highest interest rates. This is because banks have a higher demand for funds for this tenure. Banks use these funds to lend to businesses and other borrowers. Businesses need funds for short-term purposes, such as working capital requirements and inventory financing.

Three year fixed deposits

There are a few reasons why banks offer higher interest rates on fixed deposits with a tenure of around 3 years:

Asset-liability management (ALM): Banks need to maintain a balance between their assets and liabilities. Assets are what the bank owns, such as loans and investments. Liabilities are what the bank owes to its depositors and other creditors. By offering higher interest rates on fixed deposits with a tenure of around 3 years, banks can attract more deposits and maintain their ALM ratios.

Competition: Banks compete with each other to attract deposits. One way to compete is to offer higher interest rates. Banks know that businesses need funds for short-term purposes, so they offer higher interest rates on fixed deposits with a tenure of around 3 years to attract these deposits.

Liquidity: Banks need to have enough liquidity to meet the demands of their depositors and other creditors. Liquidity is the ability of a bank to convert its assets into cash quickly and without losing value. By offering higher interest rates on fixed deposits with a tenure of around 3 years, banks can attract more deposits and improve their liquidity position.

Benefits

Here are some benefits of investing in fixed deposits with a tenure of around 3 years:

Higher returns: As mentioned above, fixed deposits with a tenure of around 3 years typically offer the highest interest rates. This means that investors can earn higher returns on their investments.

Medium-term investment: Fixed deposits with a tenure of around 3 years are a good option for investors who are looking for a medium-term investment. This type of investment is ideal for investors who need to save for a specific goal, such as a down payment on a house or a child's education.

Risk associated

However, there are also some risks associated with investing in fixed deposits:

Inflation risk: Inflation can erode the purchasing power of your investment. If the inflation rate is higher than the interest rate on your fixed deposit, you will lose money in real terms.

Liquidity risk: Fixed deposits are typically illiquid investments. This means that you cannot withdraw your money before the maturity date without incurring a penalty.

Safety of fixed deposits - Deposit insurance

In India the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the Reserve Bank of India (RBI), provides deposit insurance for up to Rs. 5 lakhs per depositor per bank, including both principal and interest amounts. This insurance covers deposits in all types of accounts, including fixed deposits, savings accounts, current accounts, and recurring deposits.

The DICGC insurance is important because it protects depositors in the event of a bank failure. If a bank defaults, the DICGC will pay out the insured amount to the depositors. This insurance helps to maintain public confidence in the banking system and encourages people to save their money in banks. Here are some additional things to keep in mind about deposit insurance in India:

• The deposit insurance is per depositor per bank. This means that if you have deposits in multiple accounts at the same bank, the total amount insured will be Rs. 5 lakhs.
• The deposit insurance is for both principal and interest amounts. This means that you will be insured for the total amount of your deposit, including interest earned.
• The deposit insurance is applicable to all types of accounts, including fixed deposits, savings accounts, current accounts, and recurring deposits.
• The deposit insurance is only applicable to banks that are members of the DICGC. All scheduled commercial banks in India are members of the DICGC.

Investing in fixed deposits

Here are some additional tips for investing in fixed deposits with a tenure of around 3 years:

Compare interest rates from different banks: Before investing in a fixed deposit, compare interest rates from different banks to get the best deal.

Choose a reputable bank: It is important to choose a reputable bank for your fixed deposit investment.

Consider tax benefits: If you are eligible for tax benefits on fixed deposits, take advantage of these benefits to reduce your tax liability.

Check credit rating: You should look at the credit rating of a bank before investing in a fixed deposit because the credit rating indicates the financial health and stability of the bank. A high credit rating indicates that the bank is less likely to default on its obligations, including repaying your deposit on time and in full. A low credit rating, on the other hand, indicates that the bank is more likely to default on its obligations. This means that you may lose your investment if the bank defaults.

Overall, fixed deposits with a tenure of around 3 years are a good investment option for investors who are looking for a safe and secure way to invest their money for a medium-term period of time and earn a higher return. However, investors should be aware of the risks associated with investing in fixed deposits before making an investment decision.

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Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.