Currently, in India, banks are offering very high rates on Fixed Deposits (FD). What I am curious about is that the rate is often higher for a 1 yr lock in period than a 2 yr lock in period. I would think, the longer you park your money with the bank, the more the bank would reward you with a higher rate.
So what am I missing here?
Its based on demand and supply and what Bank think the future rates would be.
Today Banks in India have a liquidity crunch as the Repo Rates by Reserve Bank of India [Central Bank] are high.
Bank want to encourage more people to deposit money and hence are offering higher rates. Banks also believe that once the Inflation is under control, the Central Bank would ease the repo rates. This is likely to happen in a years time. Hence Banks one year down want to lower the Fixed Deposit rates. So essentially they would be at loss if they give higher rates for longer periods.
So they are offering the highest rates for a period of year which motivates more people to invest for a year, even if they want to stay invested for long.
Like Dheer said, the demand for shorter term money is greater than for longer term money, precisely because the banks don't want to have to pay big interest rates for long periods.
Banks borrow short term and lend long term - so they take money from you for one year, and lend it away as a 20 year mortgage. After a year, they take money for another year. Since short term rates tend to be higher than longer term rates, they make money off the "spread" (or the different between the rate they lend and the rate they borrow).
In this scenario, banks should pay higher for longer term deposits, but overall banks realize that interest rates will go up and down, and they don't want to lock the "up" for a longer term. Since banks believe that rates will come down in the 1-2 year period, they offer good rates only till the 1 year period and disincentivize longer term deposits by offering lower rates.
If you look at the interbank or money markets, trading of very short term bulk money shows that for the 10-15 day periods, the interest rates being offered are 10% or so, while for one year it's just 9.5%. The market believes that interest rates will go down in the one year time frame - but you never really know since this is just a bunch of people that believe so.
Eventually, if rates continue to go up, the demand at the longer term will also go up, because it will become obvious that the rate pressure continues to be strong.
If you do want higher rates for the long term, check out State bank of India bonds that are currently trading on the NSE (you can buy them if you have a brokerage account) They are just about as safe as SBI Fixed Deposits, and the rate being offered is around 9.3%, for a 10-15 year term. Hope that helps!
What the comments above say is true, but one more thing is there. FD rates are directly proportional to loan rates. However, banks make money because loan rates will always be higher than FD rates.
