How does Fixed Deposit Work

By: Bank of Baroda
Wed Jul 3, 2019
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A fixed deposit is one of the most popular investment avenues in India, particularly among risk-averse middle class investors. How does fixed deposit work? Let’s take a look.

How does a fixed deposit account work?

For that we have to understand that there are two parties involved here. One is the bank and the other is the customer. Banks need money, which they lend to borrowers from whom they charge interest. Banks obtain that money from its customers mainly through various accounts – current, savings etc.

One way of obtaining that money is through fixed deposits for which they offer certain rates of interest. The funds that they get is lent to borrowers for a slightly higher rate of interest. The difference between the interest rate on FDs and on loans is called the spread, which is the bank’s earnings.

How does fixed deposit work in India? If you have some spare cash and want to invest in fixed deposits, there are many options available for you. You can deposit money for periods ranging from a few days to a few years. Of course, the interest rates for shorter periods will be lower than those offered on fixed deposits of longer maturities. For example, if you want an FD for 30 days, the interest rate could be around 6 percent. If the deposit is for a year, the interest rate could be 7 percent.

The interest rates charged by different banks vary, so you might have to do a comparison to find the best rate. However, differences tend to be small. Smaller banks, like cooperative banks, may offer higher rates of interest than the large banks. However, you must remember that there is a direct correlation between risk and returns. High interest rates will always mean a higher level of risk.

Whether or not you choose to invest in a fixed deposit depends on how much returns you are satisfied with, and the amount of risk you are prepared to bear. Generally, returns on fixed deposits are lower than other investment avenues like equity, but the risks too are lower.

Advantages of fixed deposits

Hedge against inflation

Remember, the real value of your capital is being constantly eroded by inflation. If you have Rs 1 lakh and the inflation rate is 5 percent, the value of that Rs 1 lakh will become Rs 95,000 the next year. So depositing that cash in a fixed deposit will preserve the value of that cash.

Less risk

Fixed deposits are less risky than other investment avenues like equity. Moreover the Deposit Insurance and Credit Guarantee Corporation, a subsidiary of the Reserve Bank of India, insures FDs up to Rs 1 lakh (principal and interest), so your money is perfectly safe up to Rs 1 lakh.

Assured returns

Interest rates are fixed beforehand, so you don’t have to worry about what you’ll get when the FD matures

Now that we have explained what is a fixed deposit and how does it work, you can go ahead and open one. The process is straightforward and simple. If you have a savings account with your bank, you can open an FD with just a few clicks of your mouse. You can open an FD in other banks as well, but you have to open a savings account first. FDs are a good investment, and should be part of any investor’s portfolio.


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