RBI allows banks to offer differential interest rates on term deposits

RBI allows banks to offer differential interest rates on term deposits

The Reserve Bank of India (RBI) has allowed banks to have the discretion to offer differential interest rates based on whether the term deposits are with or without-premature-withdrawal-facility.

Liquidity or ease of withdrawal, which is often touted as the biggest advantage of bank fixed deposits, may soon be restricted due to this move. 

In the sixth bi-monthly monetary policy review held in February 2015 the central bank had decided to introduce the feature of early withdrawal facility in a term deposit as a distinguishing feature for offering differential rates of interest.

RBI said that all term deposits of individuals held singly or jointly of Rs 15 lakh and below should have premature withdrawal facility. Besides that banks have been allowed to offer deposits without the option of premature withdrawal as well.

For most banks, the penalty for premature withdrawal of deposits is 0.5 to 1 per cent below the contracted rate or the rate applicable for the period the deposit has remained with the bank. With withdrawal facility being made an option, it is possible that term deposits may become less liquid, but offer higher returns. 

According to Suresh Sadagopan, founder Ladder7 Financial Advisories, taking away the liquidity feature of bank fixed deposits reduces their attractiveness to a great extent. If for instance, they have to be locked-in for say three years, then it is better to invest in debt mutual funds, which score on taxation, even if returns of debt mutual funds cannot be predicted.

The regulator however said that banks which offer such term deposits should ensure that at the customer interface point the customers are given the option to choose between term deposits either with or without premature withdrawal facility.

Romesh Sobti, MD & CEO at IndusInd Bank said that the differential rates (slightly higher interest rates) for deposits without premature withdrawal option will help to prevent drain of funds during times of crisis. 

Premature withdrawal from term deposits, especially of higher amounts, can cause problems with banks' Asset Liability Management (ALM). "For deposits of higher amounts, at the time of withdrawal we have to arrange funds - either by borrowing in the call market or raising from the market. It becomes difficult if the withdrawal is before maturity. The new rule will help in our ALM,'' said a general manager, in charge of planning, with a public sector bank.

In case of deposits where premature withdrawal is allowed, banks may offer a lower rate of interest. "Depositors like pensioners, for instance, may prefer to get a higher rate by forgoing the premature withdrawal facility,'' the bank official said.
The differential may not be more than 25 basis points, he added.

Banks have been asked to disclose in advance the schedule of interest rates payable on deposits. Banks should also have a board approved policy with regard to interest rates on deposits including deposits with differential rates of interest and ensure that the interest rates offered are reasonable, consistent, transparent and available for supervisory review/scrutiny as and when required, said RBI.

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