The Reserve Bank of India (RBI) uses the repo rate as a tool to manage inflation and stimulate economic growth by adjusting the cost of borrowing for banks. Changes in the repo rate can have a significant impact on various financial instruments, including fixed deposits (FDs). Let’s explore how the repo rate impacts fixed deposit rates.
What is Repo Rate?
The repo rate is a short-term lending rate that allows financial institutions to borrow from the RBI. A lower repo rate enables these institutions to borrow more cheaply, which can lead to lower FD rates for consumers.
How Does Repo Rate Impact FD Rates?
Though the FD rates are not directly linked to the repo rate, any changes in the repo rate do impact deposit rates. This is because when the repo rate changes, it affects the marginal cost of the funds-based lending rate (MCLR), the benchmark interest rate set by banks.
Financial institutions price their lending rates incrementally above the MCLR. So, if the MCLR rises due to an increase in the repo rate, financial institutions have to pay more for funds, which are passed on to customers.
Consequently, the FD interest rates offered by financial institutions rise. On the flip side, if the repo rate reduces, banks and NBFCs can access funds at cheaper rates from the RBI, and hence, they reduce their loan rates as well as deposit rates.
The correlation may not be one-to-one; financial institutions may adjust their FD rates in line with changes in the key policy rates.
Factors that Impact FD Rates
While the repo rate affects deposit rates, it is not the only factor that determines the FD rates. Some other key factors are:
- Credit growth in the economy: When credit growth is high, financial institutions require more funds, and hence, FD rates tend to rise.
- Liquidity scenario: If liquidity is tight, deposit rates tend to go up, and when liquidity is ample, financial institutions are comfortable reducing FD rates.
- Cost of funds: The interest rates financial institutions must pay to raise funds from sources like bonds, interbank borrowings, etc., also influence deposit rates.
- Competition: To attract more deposits from customers, banks and NBFCs also have to consider competition and match interest rates offered by peers.
- Tenure: Longer-duration FDs usually get higher interest rates. So, tenure is also a key factor in determining FD rates.
- Customer profile: Financial institutions may offer higher rates to high-value customers compared to ordinary investors.
Thus, along with the RBI's repo and MCLR, these factors also drive FD interest rates.
Recent Repo Rate Cut by RBI and Impact
The RBI reduced the repo rate by 25 basis points (bps) to 6.25% in its latest monetary policy review on February 7, 2025. This is the first rate cut since 2019, following easing inflation and a comfortable current account deficit position. This move signals the reversal of the RBI's tight monetary policy stance.
For borrowers, the repo rate cut brings welcome relief. Financial institutions typically transmit this cut to reduce their loan interest rates after a few weeks to months. This means home, auto, and other loans could get cheaper soon.
However, for depositors, this signals lower returns on FDs going forward. Financial institutions are likely to gradually reduce FD rates in line with the RBI's policy stance.
The bias is towards lowering interest rates in the economy to support growth. Hence, depositors need to be prepared for lower returns on traditional FDs in the coming months once financial institutions adjust their interest rates.
Retirees and conservative investors who rely on traditional FD income may be impacted the most by the falling interest rate scenario triggered by the repo rate cut. They may explore options to shield their income, such as RBI floating-rate bonds, debt mutual funds, etc., that can benefit from future rate declines.
Impact on Depositors
A falling repo rate is generally good news for borrowers as it benefits them because banks and financial institutions typically lower loan interest rates, reducing their monthly payments (EMIs). That said, this drop can negatively affect depositors, as the interest earned on FDs gradually declines, impacting those who rely on this income, especially retirees.
In the long run, lower interest rates can stimulate economic growth, which may lead to better returns on various investments, including FDs, indirectly benefiting investors.
Conversely, when the repo rate rises, banks and financial institutions swiftly increase loan rates, leading to higher EMIs for borrowers while offering better returns for depositors on their FDs.
How to Get the Best FD Interest Rates?
When the repo rate is falling, you can optimise FD returns by:
- Choosing short-term 1-2 year FDs where rate transmission is slower
- Considering small finance banks and niche banks or NBFCs that may offer better rates
- Negotiating rates with your financial institutions for larger deposits
- Using FD laddering to benefit from current high rates on longer FDs
- Opting for non-callable FDs where rates are locked in compared to callable deposits
- Opening high-value senior citizens FDs that give additional 0.25-0.50% extra rates
By choosing the right tenures and financial institutions, you can maximise FD returns even when overall interest rates are declining in the economy.
Summing Up
While the RBI's repo rate and banks' MCLR serve as benchmark rates, the actual FD interest rates are also influenced by liquidity, credit offtake, cost of funds and competitive factors.
The correlation between falling repo rates and deposit interest rates is not instant. Financial institutions tend to adjust deposit rates with a lag after assessing their funding requirements and profitability.
As a depositor, understand this correlation and time your investments prudently to earn optimal returns on your hard-earned savings.
