Banks have been raising interest rates on fixed deposits of various tenures by 0.5-0.75% in the past two weeks. A three-year FD in the second week of December 2010 was earning as much as 8.30-8.50%. The interest rate has since swelled to 9%. A senior citizen might even earn 10% by picking the right bank FD.
In this backdrop, it is tempting to withdraw an FD and deposit the money with a bank offering a higher interest rate. Here is why you should not rush.
Banks usually levy a penalty in the form of a 0.5-1% lower interest on customers looking to ditch their account for a rival’s.
"When the interest rate goes up in quick succession, people will start breaking existing deposits. Bank will feel the pressure," says S Govindan, general manager of personal banking and operations department at Union Bank of India. Banks are okay with customers reinvesting money with them, though there are exceptions.
HDFC Bank is one. The bank has said it will charge a 1% penalty on premature withdrawals for all fixed deposits, including sweep-in FDs (accounts that combine savings-current and fixed deposit features) and partial closures, from 24 January 2011.
Penal interest
ICICI Bank already charges a 0.5-1% lower interest rate to end an FD. The penal interest is 0.5% for a one-year deposit and 1% for deposits below `5 crore but with a higher tenure. A spokesperson of ICICI Bank said the penalty applies even if the money is re-invested.
Not every bank imposes a sweeping fine on withdrawals. IDBI Bank said last week it will not fine new or renewed FDs opened from January 1, 2011.
The penalty of 1% lower interest when people renew existing FDs or open a new deposit will now be waived off, says RK Bansal, executive director and chief financial officer of IDBI Bank.
If you break the FD now
It is a customer-friendly measure, says Bansal. People want to re-invest when rates rise, he says, though FD termination creates an asset-liability mismatch for the bank.
Like IDBI, public sector counterparts such as State Bank of India , Bank of Baroda , Punjab National Bank and Union Bank of India also impose a charge on premature withdrawal, even if it is partial. There is no fine on a deposit renewed for higher interest rate, said officials of these banks.
UBI’s Govindan says there was always a penalty on breaking an FD. UBI charges a lower interest rate of 1% on an FD removal. "But if you re-invest the same amount for a period higher than the remaining period of the original FD, the penalty is waived off," he says.
The waiver is paying off. "We are seeing people who were in for the shorter term are breaking existing FDs and going for the longer-tenure FDs because of the attractive interest rate," says Govindan.
The Reserve Bank of India had asked banks to allow conversion of fixed, recurring or daily deposits for reinvesting without reducing the interest as a penalty. In April 2010, RBI reversed its stance, saying banks can decide their own charges if people convert deposits to earn higher interest.
The leeway to banks means a rethink on pulling out money is in order. For a customer, it pays to calculate the penalty as some banks do not tell upfront about the charges while ending an FD prematurely. The accompanying tables will help you decide.
"Breaking an FD is helpful to a customer only if there is a rapid increase in interest for two weeks or one month as we have seen now," says Govindan. "If the rate moves up in the range of 300 bps (3%) in quick succession, you benefit."
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