COMMERCIAL BANKING: FIXED DEPOSIT ACCOUNTS

Introduction:  In a previous article, we had examined various types of depsit accounts, available to the customer of  a typical commercial bank.   In this article, we shall take a look at the different kinds of Fixed Deposit Accounts offered by the Commercial Banks.   Please note that Banks, in different geographical locations, may offer variations of these fixed deposit accounts.   However, most of the commercial banks do offer the following types of fixed deposit accounts to their customers.

Fixed Deposit Accounts:  Fixed Deposits, as we know, are sums of money kept with the Bank, for a specific period, and for a specific rate of interest payable on them.   These deposits are not repayable on demand.   There are certain conditions attached to their repayment before the completion of the period of the deposits, usually a penalty in regard to the interest rate paid on such deposits.

Basically, Fixed Deposits are of two types- Cumulative and Non Cumulative.   In the cumulative type of deposits, the interest payable on the deposits is compounded periodically, unlike in the non cumulative variety.

Non Cumulative Fixed Deposit:  These deposit accounts may be of two types.   One,  that are kept with the Bank for a  certain period that does not fetch compound rate of interest.   For example, say, a Bank offers a non cumulative fixed deposit for 60 days at 2% rate of interest.   And further, it offers same rate of interest of 2% on a 90 day deposit, but on compounded basis.   Likewise, different rates of interest are offered on deposits kept for multiples of 90 days, i.e., 180 days, 270 days and so on.

In the above scenario, say a customer makes a deposit of USD: 100,000.00 for 60 days, at 2% rate of interest.   At the end of 60 days, he would be repaid the principal amount of USD:100,000.00 along with interest of USD:333.00.   A total of USD:100,333.00.   

In the second case, a customer may deposit, say, USD:100,000.00 for one year at 5% rate of interest, with interest being payable monthly.   Here, even though the customer has deposited the money for a period of 1 year that attracts a compound rate of interest, in this particular case, the Bank pays only simple interest, because the customer wishes to draw the amount of interest every month.   Therefore, the customer would be paid a monthly interest of approximately USD:416.00, while the deposit amount of USD:100,000.00 remains with the Bank.   This deposit is repaid at the end of the 1 year period, as contracted, without any addition of interest to it.   This type of deposit is suitable for people who require a monthly income.

Cumulative Fixed Deposits:  In these type of deposits, the Bank pays a compound rate of interest, that is, interest is paid periodically, usually quarterly, as shown in the example on the non cumulative deposits above, and the same is clubbed with the principal amount, and this new consolidated amount becomes the principal for the next quarter, and so on.   This process continues till the maturity period of the deposit, whereupon, the entire amount of the deposit, inclusive of the interest amount, is repaid in lumpsum, to the depositor.

The above type of cumulative fixed deposit fetches the maximum rate of interest, as the same is not withdrawn, but ploughed back into the deposit.   The Bank is able to pay a higher rate of interest on such deposits, on account of the certainty of the tenure of the deposits.   This enables the Bank to take a view of the market, and decide upon the most profitable avenues of investment open to it at that point of time. 

An interesting point to note here, is, Banks may not invariably offer a higher rate of interest on deposits of longer maturities.   The rate of interest offered on different maturities depends upon the Asset-Liability match of the Bank.   That is, the Bank offers a higher rate of interest on deposits of such maturity as it requires funds for.   Suppose the Asset-Liability match of a particular Bank is such that it requires more funds in the 1 year slot rather than the 2 year one.   Then, this Bank would offer a higher rate of interest on deposits of one year maturity than the 2 year ones!

Another type of cumulative fixed deposit is where the depositor is allowed to withdraw the interest amount at the end of each quarter, and the Principal amount is repaid at the end of the tenure of the deposit.   In this type of deposit, the Bank will pay compound rate of interest, but the amount of interest itself would be less than that paid on deposit where interest amount is not withdrawn in between.   Because of the reason that here, the interest amount is not being ploughed back into the deposit.  This particular type of deposit is suitable for people that need a regular income periodically, and not necessarily every month.

As a customer, please do study your requirements, and if necessary, consult your Banker, before deciding upon the type of deposit that suits your requirements.

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