Fixed Deposits have long been considered a relatively stable investment option for risk-averse investors. They typically offer predetermined interest rates and are generally perceived as less volatile compared to market-linked investments such as stocks or mutual funds.

Therefore, it's a preferred choice for people looking forward to reducing their portfolio risk. However, even though fixed deposits are fixed-income instruments, financial institutions revise FD interest rates from time to time.

This is because fixed deposit interest rates are influenced by monetary policies implemented by the Reserve Bank of India (RBI). Let’s first understand the mechanism before examining these factors in detail.

How fixed deposit interest rates fluctuate

Various factors influence FD interest rates offered by banks, NBFCs, and other regulated financial institutions:

• Demand and supply

If borrowing demand increases in the economy, financial institutions may need more funds to lend, and therefore may offer more competitive deposit interest rates to attract investors.

If credit demand slows, institutions may not need to raise as many deposits, which can result in stable or lower deposit rates.

• Inflation and Monetary Policy

When inflation rises, the RBI may increase policy rates to control it. Higher policy rates generally increase borrowing costs across the financial system.

This may lead banks and NBFCs to revise deposit interest rates, depending on their cost of funds and funding requirements.

• Liquidity in the Financial System

Liquidity refers to the availability of funds within the financial ecosystem.

If liquidity is abundant, banks and NBFCs may not aggressively compete for deposits, which can keep FD rates stable.

During tighter liquidity conditions, institutions may increase deposit rates to mobilise additional funds.

What does an increase or decrease in fixed deposit rates mean?

If there is an increasing trend in the fixed deposit interest rates, then it means that the RBI is encouraging savings among the public and discouraging spending. Also, the borrowings may become costlier as the financial institutions may charge more interest to meet its cost of funds. Alternatively, if the interest rates are falling, then it means that steps are being taken to encourage the public to spend more on goods, commodities and services. Borrowings will get cheaper, allowing people to take more to spend. This in turn channelizes the rotation of money in the economy.

Points to keep in mind while investing in fixed deposits

• If you are an investor and want your investments to be almost risk-free, you can consider investing in fixed deposits.
• Senior citizens get an additional interest rate of 0.50%* p.a.
• The amount of interest earned gets accumulated in fixed deposits, which is then compounded to increase the value. The principal, along with interest, is paid at maturity and is therefore known as a cumulative fixed deposit.
• In the case of non-cumulative fixed deposits, the interest is not accumulated but is instead paid out to the depositor on a monthly/quarterly/half-yearly/yearly basis.
• Also, the liquidity of  fixed deposits  depends on the tenure chosen. The amount gets locked in for the tenure of the deposit, and if withdrawn prematurely (i.e., before maturity), then penal charges will be levied by the financial institution.