Understanding How Repo Rate Changes Affect FD Rates

Have you ever wondered why RBI rate increases might affect your savings? This is where the dynamics of the repo rate come into play.

As of December 8th, 2023, the current RBI repo rate in India is set at 6.50%. This key rate influences the interest rates banks can provide on deposits. It plays a crucial role in shaping the country’s financial landscape, including the interest rates on Fixed Deposits (FDs). 

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What is Repo Rate?

Repurchase Agreement or Repurchasing Option (Repo Rate) is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks for short-term fund requirements. Banks can borrow from the RBI at the repo rate, providing government securities as collateral.

How Does Repo Rate Work?

Suppose the Reserve Bank of India (RBI) sets a repo rate of 4%. This means a commercial bank can borrow money from the RBI at a 4% interest rate. 

If a bank needs ₹100 million, it borrows from the RBI and pays ₹104 million back, considering the interest. This rate influences the overall lending rates in the economy, impacting loans and savings.

The Effects of Change in Repo Rate on Fixed Deposits Rates

When we talk about the impact of the repo rate increase on financial instruments, it’s crucial to understand how this affects FD rates after repo rate increase. The connection between the repo rate and FD interest rates is direct and significant.

Banks adjust FD rates in line with repo rates to manage borrowing costs and attract deposits. Not aligning rates can lead to liquidity issues when repo rates rise, and reduced profitability and competitiveness when they fall. This alignment ensures financial stability and market relevance.

When the repo rate goes up by 0.5%, banks typically also raise their fixed deposit interest rates. For example, when a bank raised its fixed deposit rate from 6% to 6.5% in line with the central bank’s 0.5% rate hike, interest earnings on a ₹1 lakh deposit increased by ₹500 annually – from ₹6,000 to ₹6,500.

The Effects of Change in Interest Rate on Ongoing Fixed Deposits Returns

The fluctuation in the repo rate can have various implications for ongoing fixed deposits:

• Longer-term FDs feel the repo rate increase effects on fixed deposits more. They can miss out on the new, higher rates.

• Higher repo rates mean new fixed deposits (FDs) offer better interest than older ones at lower rates. When FDs mature during high repo rates, reinvestment can yield improved returns.

Final Thoughts 

The repo rate increase impact on FD is a key indicator for investors monitoring their fixed deposit returns. As the repo rate fluctuates, it directly influences the interest rates on FDs, shaping your investment outcomes. 

Keeping track of changes in the repo rate is essential for any investor, as these changes directly influence the attractiveness and profitability of fixed deposits.

FAQs

Does repo rate affect fixed interest rate?

Yes, changes in the repo rate can influence fixed interest rates, including those on loans and deposits.

What happens to FD when repo rate increases?

When the repo rate increases, banks often raise FD rates, making fixed deposits more attractive to savers.

What affects FD interest rates?

FD interest rates are influenced by several factors, including RBI’s repo rate, market conditions, and banks’ liquidity needs.

Why are FD rates increasing?

FD rates are increasing primarily due to a hike in the repo rate, which prompts banks to offer higher rates on deposits to attract more funds.

Will the FD rate increase in 2023?

Yes, there’s a trend of increasing FD rates in 2023. For example, the Bank of India revised its FD rates for deposits ranging from ₹2 crore to less than ₹10 crore, offering rates from 5.25% to 7.25% for various tenures starting December 1, 2023.

Should I withdraw from the current FD if there is an increase in FD rates?

Generally, it’s advisable to avoid breaking your FD prematurely, as it could result in a lower interest rate and a penalty for early withdrawal.

How does the repo rate affect investment?

Repo rate changes can impact investment decisions by influencing the returns on different investment instruments, including FDs.

How does the repo rate affect savings?

Changes in the repo rate can affect the interest rates on savings, including FDs, altering the returns you earn on your savings.

Does inflation affect FD?

Yes, inflation can impact the real returns of FDs, as higher inflation can erode the purchasing power of the interest earned.

Why are FD rates not increasing with repo rate?

Sometimes FD rates may not increase in tandem with the repo rate due to other factors influencing a bank’s liquidity and funding needs.

Which repo rate is always fixed?

The repo rate is not fixed; it is regularly reviewed and adjusted by the RBI based on economic conditions.

What happens to FD when repo rate increases?

Typically, an increase in the repo rate leads to higher FD rates, offering better returns to depositors.