A number of banks are wooing depositors by hiking interest rates on short-term fixed deposits. You can go for them but only after taking various factors into account

A number of commercial banks (both private and public sector) are offering interest rates on short-term deposits (maturities up to 1 year) that are much above the interest rates offered on savings bank account (4 per cent in most cases).

For instance, the country’s largest lender, the State Bank of India (SBI), revised interest rates on short-term deposits on July 1. For domestic term deposits of below Rs 15 lakh, the bank is now offering 7 per cent interest for seven days to 179 days tenures, 7.25 per cent for 181 days to 240 days, and 7.5 per cent for 241 days to less than one-year maturity period.

The largest private lender, ICICI, too, has recently revised interest rates on short-term deposits below Rs 15 lakh. For general customers (who’re not senior citizens), the bank is offering 5 per cent for 30 days to 45 days maturity, 6.25 per cent for 46 days to 60 days, 6.5 per cent for 61 days to 90 days, 7 per cent for 91 days to 184 days, 7.5 per cent for 185 days to 289 days, and 7.75 per cent for 290 days to less than one-year maturity period. For senior citizens, the rates are a bit higher. In May, the Punjab National Bank too revised interest rates on short-term deposits for amount less than Rs 1 crore. The bank is offering 4.5 per cent interest on 15 to 45 days term deposits, 5.5 per cent on deposits of 46 to 90 days, 6.75 per cent for 91 to 179 days, and 7.5 per cent each for 180 days to 270 days as well as for 271 days to less than 1 year deposits.

Many other banks such as Kotak and ING Vysya Bank have also just revised interest rates on such deposits. Doesn’t it sound attractive? But there are a host of factors you need to consider before you switch funds from your savings account to short-term deposits to make quick bucks.

Do home work
First of all, you need to be sure of how much fund you require in the next three to six months in your savings account after keeping aside enough to meet exigencies. If you park the entire fund lying in your savings account into short-term deposits, you could be putting yourself to financial risk and may find it extremely difficult to arrange money should you require it in emergency conditions.

As Anup Bhaiya, Managing Director, Money Honey Financial Services, Mumbai, says, “A person with Rs 10,000-20,000 as average balance in his savings account would normally not go for such short-term deposits simply because they can’t afford to lock in their money for six to nine months that is too small in amount.”

Of course, these deposits are liquid that can be prematurely withdrawn in time of need, but it would attract a penalty which ultimately would wipe out the gains you would have earned on them.   
“If you can block the money for three, six or nine months’ period, it’s better to move to short-term fixed deposits as these deposits can give additional 2 to 4 per cent above the normal savings account interest,” maintains K. Ramesh Bhat, CEO, Aniram, a financial planning and services firm, Chennai.

However, you need to check with the bank whether there is a minimum balance that you have to keep in your savings account. Some multinational banks generally discourage customers from going for short-term deposits unless they maintain an average balance of Rs 1 to 2 lakh in their savings account. Further, although premature withdrawal from short-term deposits attracts penalties of up to 1 to 2 per cent, some banks waive off this provision to attract customers. So, check this out before parking your money.

Time horizon
Another point to look at before you switch funds to short-term deposits is the rate of return that you’re targeting to achieve in a given timeframe. In other words, if you’re targeting a return of, say, 8 to 9 per cent return on your investment, investing in short-term deposits may not be an appropriate option. For that, you need to park your money in long term fixed deposits (maturities of more than a year). Many banks are offering interest rate up to 9 to 9.24 per cent for maturities of 2 to 5 year tenure.  

Here’s a simple calculation. Suppose you’re planning to switch Rs 1 lakh into a short-term deposit for up to one-year maturity offering 7.5 per cent interest. In your savings account, this money would give you a return of Rs 4,000 in a year (assuming interest rate of 4 per cent per annum), while in a term deposit of up a year maturity, the return would be Rs 7,500.

The difference of return between the two is Rs 3,500 in a year. Now you have to decide here whether this sum of Rs 3,500 is big enough for you to switch your money.

“The rationale behind short-term deposits is not investment but parking surplus funds and getting a higher return than a savings account offers. This makes them different from long-term fixed deposits (with tenure of more than a year) where the main purpose is investment,” adds Anup Bhaiya of Money Honey Financial Services.

For banks, short-term maturities are an effective tool to shore up their deposits and improve the Net Interest Margin (NIM). Generally, banks tend to hike interest rates on short-term maturities towards the fag-end of the financial year, i.e., February to March, to prop up their deposits.
However, tweaking of short-term deposit rates by banks is also guided largely by the rates prevailing in the call money market (the market for short-term lending/borrowing among banks). In the months of April-June, for instance, the call money market rate has moved up and has been hovering around 7 to 8 per cent, enabling banks to generate a higher alpha. That’s why many banks have hiked interest rates on short-term deposits.

This close link of short-term deposits with the call money market rates also makes them susceptible to interest rate fluctuations.

As Bhat argues, “If the call money market rates and lending rates go down in the months to come, banks would lowers rates on such deposits.” Moral of the story is: don’t just get carried away by higher interest rates on short-term deposits; take various factors into account before opting for such deposits.