A Fixed Deposit (FD) is a type of deposit account offered by banks and non-bank financial institutions where a customer deposits a lump sum amount for a fixed tenure at a predetermined interest rate. This deposit is made for a specific period, and the amount is locked in until the maturity date. Fixed deposits generally offer higher interest rates than regular savings accounts due to the lack of liquidity, meaning that the deposited money cannot be withdrawn before the maturity date, unless a penalty is applied.

• Common Terminology:
  • In India and the U.S., it is referred to as Fixed Deposit.
  • In other countries like Canada, Australia, and New Zealand, it is known as Term Deposit or Time Deposit.
  • In the United Kingdom, it is called a Bond.

Fixed Deposit (FD) Formulas

Key Features of Fixed Deposits

1. Non-Liquidity:
   • Unlike a Recurring Deposit or Demand Deposit, the money in a Fixed Deposit cannot be withdrawn before the maturity date. This is called low liquidity.
   • To offset this limitation, FD accounts provide higher interest rates than savings accounts.
2. Fixed Tenure:
   • The tenure of an FD can vary, typically ranging from as short as 7 days to as long as 10 years. Normally the minimum duration is 6 months for majority of banks.
   • Longer tenure generally comes with higher interest rates, but banks may offer lower rates if they anticipate falling interest rates in the future.
3. Interest Rate:
   • FD interest rates are fixed for the entire tenure. The longer the tenure, the higher the rate, though this is also dependent on market conditions and central bank policies.
   • The central bank’s policy (repo rate) plays a significant role in determining the interest rates offered by banks for Fixed Deposits. When the repo rate rises, FD rates tend to follow suit, making FDs a more attractive investment option in times of high inflation.
4. Interest Payments:
   • Banks offer Simple Fixed Deposits where interest is paid periodically (usually quarterly or annually) to the depositor’s savings account.
   • Alternatively, Cumulative Fixed Deposits allow the interest to be reinvested and paid along with the principal at the end of the FD term, thus earning compound interest.
5. Premature Withdrawal:
   • In cases where the customer needs the funds before the FD matures, premature withdrawal is allowed, though penalties may be charged.
   • For example, if an FD is made for 5 years at 8% interest but withdrawn after 2 years, the interest would be calculated at the rate applicable to a 2-year FD (e.g., 5%).
6. Fixed Deposit Receipt (FDR):
   • A Fixed Deposit Receipt (FDR) is issued for each FD and serves as a proof of the deposit. It contains details of the amount, interest rate, and tenure.
   • The FDR must be surrendered when renewing or encashing the FD.
7. Automatic Renewal:
   • Banks may offer automatic renewal, where the FD is renewed for the same term at the interest rate applicable on the maturity date, without requiring any new instructions from the customer.

Safety and Security of Fixed Deposits in India

1. Deposit Insurance:
   • Fixed deposits in India are insured by the Indian Deposit Insurance and Credit Guarantee Corporation (DICGC), which provides a guarantee of up to ₹500,000 per depositor per bank.
   • This means that if the bank defaults, the depositor is assured of getting up to ₹500,000 back.
2. Tax Benefits:
   • Fixed deposits in India offer certain tax-saving benefits. Tax-saving Fixed Deposits are eligible under Section 80C of the Income Tax Act, allowing customers to claim deductions on their taxable income.

Types of Fixed Deposits

1. Simple Fixed Deposit:
   • Interest is paid periodically, either monthly, quarterly, or annually, depending on the bank’s terms.
   • Interest payments are credited to the depositor’s linked savings account or sent by cheque.
2. Cumulative Fixed Deposit:
   • The interest earned on the FD is reinvested back into the deposit, and the total amount (principal + interest) is paid out at maturity.
   • This option offers the benefit of compound interest.
3. Flexi Fixed Deposit / Sweep-in FD:
   • Combines the features of both a demand deposit and a fixed deposit.
   • The depositor can withdraw funds from the FD through ATM withdrawals, cheques, or fund transfers.
   • Interest earned on withdrawn funds is credited to the linked savings account, and the remaining balance is automatically converted to a new FD.

Loans Against Fixed Deposits

• Banks allow customers to avail loans against their Fixed Deposits, typically offering loans of up to 80-90% of the FD value.
• The loan interest rate is usually 1-2% higher than the FD rate.
• This option provides liquidity without breaking the FD.

Taxation of Fixed Deposits in India

1. Tax Deducted at Source (TDS):
   • If the interest earned on Fixed Deposits exceeds ₹10,000 in a financial year, TDS is deducted by the bank at the rate of 10%.
   • TDS is applicable to both payable and reinvested interest.
   • Banks issue Form 16A quarterly, which serves as a receipt for the TDS.
2. Taxable Income:
   • The tax on FD interest depends on the depositor’s tax slab. If the TDS deducted is insufficient, the depositor must declare the additional tax in their Income Tax Return.
3. Exemption from TDS:
   • If the total annual income is below the taxable limit, customers can submit Form 15G (for those below 60 years) or Form 15H (for those above 60 years) to the bank, exempting them from TDS.
   • These forms should be submitted at the time of opening the FD or annually at the start of the financial year.

How Central Bank Policies Affect FD Interest Rates

1. Monetary Policy and Repo Rate:
   • The repo rate (the rate at which the central bank lends money to commercial banks) directly influences FD interest rates. When the central bank raises the repo rate to combat high inflation, commercial banks generally increase the interest rates they offer on fixed deposits to attract deposits.
   • High FD rates make Fixed Deposits an attractive investment option during periods of high inflation since they offer stable returns with minimal risk.
2. Impact of High Inflation:
   • During inflationary periods, central banks may adopt a tight monetary policy, raising the repo rate, which in turn increases FD rates, making them a more lucrative option for investors seeking secure returns.

Conclusion

Fixed Deposits are an attractive investment option due to their higher interest rates, tax benefits, and security. They offer safe, risk-free returns while ensuring liquidity constraints (i.e., not withdrawing before maturity) in exchange for better interest rates. They are ideal for individuals who have a fixed sum of money to invest for a specific period and who do not need immediate access to these funds. However, the impact of central bank policies and inflation can influence FD rates, making it important for investors to monitor these factors when choosing FD tenures and banks.