The Telegraph
Since 1st March, 1999
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Maximise returns

Six months ago, one could choose bank fixed deposits over small savings schemes without even thinking twice. Bank deposits fetched 10.5 per cent interest compared with 8 per cent in small savings schemes.

Since January, banks have been reducing their deposit rates that now stand between 8 per cent and 8.5 per cent.

With bank fixed deposits and small savings schemes offering competitive interest rates, the big question is whether one should put one’s money in banks or post offices.

However, a closer look at the two options reveals that bank fixed deposits still score over small savings schemes.

Rate logic

The interest rate in post office schemes, except for term and recurring deposits, is either annually compounded or half-yearly compounded, while the interest rate on bank fixed deposits is compounded quarterly.

Let us explain why the method of interest compounding is important.

Compound interest means interest earned on interest. Hence, the more frequent the compounding, the more can one earn on the same principal (see chart).

So, the same amount will fetch a greater return in a bank than in a post office though both are offering the same rate of interest.

Small savings schemes usually have a maturity period of six years and above. In comparison, you can earn an 8 per cent interest on bank fixed deposits for two years and between 8.5 per cent and 8.75 per cent for five years. Thus, bank deposits score over small savings schemes on both counts — interest rate and the frequency of compounding.

Senior relief

A third advantage with bank fixed deposits is that senior citizens get 0.50 percentage points more than the card rate. This facility, however, is not available with the post office schemes.

Senior citizens can get a higher interest rate of 9 per cent only in the Senior Citizen Savings Scheme (SCSS) having a lock-in period of five years.

However, post office schemes are favoured by many because tax deduction at source is not applicable in any of these instruments, except for SCSS.

Banks are bound to deduct tax at source at the rate of 10 per cent if a depositor’s total interest income from various deposit accounts exceeds Rs 10,000 in a financial year.

This provision forces elderly people with no taxable income to file Form 15H with the banks at the beginning of every financial year.

Since small savings schemes are sponsored by the central government, the finance ministry arbitrarily fixes the interest rates on these schemes. Hence, the volatility in interest rates on small saving schemes is far less than that in bank fixed deposits. Given this, bank fixed deposits are best suited for investment covering one to three years — interest rates on longer term are generally much lower than deposits of one to three years.

Present tense

Let us now consider the interest outlook at present.

With the inflation rate approaching zero and the Reserve Bank adopting an easy monetary policy to boost credit demand, banks may be forced to slash their deposit rates further to be able to lower their lending rates.

Commercial banks have been arguing that they can’t reduce their deposit rates further because of competition from small saving schemes.

Post offices are offering 6.25 per cent interest on one-year fixed deposits, while the interest on a five-year term deposit is 7.5 per cent.

In comparison, banks are still offering at least one percentage point more.

In other words, there is still room for a 50-basis-point cut in bank fixed deposit rates if the economic slowdown continues and inflation turns negative.

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