Bank FD interest rates 2024

Bank FD Interest Rates Touch 9.5%; Why It’s Time to Change the Taxation of Fixed Deposits

Introduction

Fixed deposits (FDs) have long been a preferred investment choice for risk-averse individuals, particularly for their safety and guaranteed returns. However, the landscape of fixed deposits is evolving, and recent trends suggest a need for reevaluation of their taxation policies. As FD interest rates reach a high of 9.5%, with 47% of these deposits now held by senior citizens, there is growing advocacy for a shift in how FDs are taxed. This article delves into the reasons behind the call for change and the impact it could have on deposit growth in India.

Current State of Bank Deposits

Deposit Growth vs. Credit Growth

According to a recent SBI Research report, the growth in banking sector deposits has been robust since FY22, reaching ₹61 trillion, outpacing credit growth, which stands at ₹59 trillion. Contrary to popular belief, the notion of flagging deposit growth is not supported by the data. However, challenges remain, particularly with the decline in Current Account and Savings Account (CASA) deposits, which are being increasingly used for UPI transactions and are moving across the banking system. The report highlights the need for a fair tax treatment on interest earned from deposits to support sustained growth.

Decline in CASA Deposits

CASA deposits have seen a decline from 43.5% in FY23 to 41.0% in FY24, aligning more closely with pre-pandemic levels. This decline is attributed to the growing use of Savings Bank (SB) deposits primarily for transaction purposes, particularly UPI transactions. As interest rates rise, there has been a noticeable shift from CASA deposits to term deposits, which now constitute 59.0% of total deposits, up from 56.5% in FY23.

The Rise in FD Interest Rates

The increasing interest rates on fixed deposits have driven a compositional shift in bank deposits. On an incremental basis, term deposits accounted for nearly 78% of total deposits in FY24, with the share of CASA deposits declining. This trend is expected as higher interest rates make term deposits more attractive compared to CASA deposits.

Average Ticket Size of FDs

Public Sector Banks (PSBs) have been instrumental in mobilizing low-ticket deposits across the banking spectrum. The average ticket size of SB/Term deposits in PSBs is ₹72,577, compared to ₹1.60 lakhs in Private Sector Banks and ₹10.5 lakhs in Foreign Banks. PSBs have also been more active in rural and semi-urban (RUSU) regions, contributing to a significant increase in deposits by women, particularly through Self-Help Group (SHG) linkages.

Who is Investing in Bank FDs?

Despite their safety and liquidity, bank deposits are increasingly being viewed as less attractive due to lower returns compared to riskier assets like mutual funds and equities. The SBI report indicates that 47% of term deposits are now held by senior citizens, while younger investors are shifting towards the capital markets. The median age of investors in capital markets has dropped to 32 years, with approximately 40% of these investors being under 30. This demographic shift underscores the need for a review of the taxation policies on fixed deposits to make them more appealing to younger investors.

The Case for Changing FD Taxation

Current Taxation Issues

The current tax regime for fixed deposits is seen as a deterrent for potential investors. Interest on FDs is taxed on an accrual basis, meaning that interest is taxed each year even if it is not withdrawn. This can be less favorable compared to other investment options that may offer more tax-efficient returns. The SBI Research report suggests that this tax treatment contributes to a 7% reduction in deposit growth.

Proposed Taxation Reforms

SBI economists advocate for a reform in the taxation of fixed deposits, suggesting that interest should be taxed at the time of redemption rather than on an accrual basis. This change would align the tax treatment of FDs with other investment products like mutual funds, which are taxed only upon redemption. The report also recommends delinking the tax treatment of FDs from the highest income bracket and treating them as a distinct asset class with potentially different tax implications.

The Impact of Taxation on Deposit Growth

The SBI report provides a detailed analysis of the impact of taxation on deposit growth using data from 1970-71 to 2023-24. The findings reveal that for every ₹1,000 increase in per-capita income, deposits could increase by ₹652 if not for the tax impact. With taxes considered, the increase is only ₹613, indicating a 7% negative impact due to taxation. This analysis strengthens the argument for a uniform tax treatment of deposits, similar to short-term and long-term capital gains tax on other assets.

Conclusion

As the financial landscape evolves, it is crucial to reassess the taxation policies on fixed deposits to ensure they remain an attractive investment option for all age groups. With rising FD interest rates and a significant portion of these deposits held by senior citizens, revisiting the tax treatment could help rejuvenate interest in fixed deposits, particularly among younger investors. A fair and uniform tax policy could also support sustained deposit growth, contributing to the overall stability of the banking sector.

FAQs

Why are fixed deposits currently taxed on an accrual basis?
Fixed deposits are taxed on an accrual basis, meaning interest earned is taxed annually, regardless of whether it is withdrawn or reinvested. This tax treatment can make FDs less attractive compared to other investment options that are taxed only at redemption.
How would changing the tax treatment of FDs impact investors?
Changing the tax treatment to tax interest at the time of redemption rather than annually could make FDs more appealing, particularly for younger investors who currently prefer riskier, tax-efficient assets like mutual funds and equities.
What is the significance of senior citizens holding 47% of FDs?
The fact that 47% of FDs are held by senior citizens highlights the reliance of older individuals on FDs for secure, low-risk investments. This demographic trend suggests the need for policies that ensure FDs remain a viable option for all age groups.
How does the decline in CASA deposits affect the banking sector?
The decline in CASA deposits, which are increasingly being used for transaction purposes, particularly UPI transactions, indicates a shift towards term deposits in response to rising interest rates. This trend affects the overall composition and stability of bank deposits.
What role do Public Sector Banks play in deposit mobilisation?
Public Sector Banks have been at the forefront of mobilizing low-ticket deposits, particularly in rural and semi-urban areas. Their efforts have contributed to a significant increase in deposits, particularly among women, through initiatives like SHG linkages.