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?

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    This reminds me of an inverted yield curve, where short-term rates are higher than long-term rates that may be useful - investopedia.com/articles/basics/06/invertedyieldcurve.asp – JB King Jul 30 '13 at 18:42
  • i have a question, why are interest rates different in india and America or another country. I'm trying to ask why is the interest rate 8% in india whereas 3-4 % in america or lesser.? – user22879 Dec 4 '14 at 16:39
  • @AdityaWaadhawan That is a good question. You should ask it formally. Though it might be a better question for the quant finance SE. I'm not sure of the best place for it. – rhaskett Dec 4 '14 at 18:41

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.

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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!

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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.

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    Do you have a source for India receiving loans from the IMF? I'm not sure how "developing countries are high risk" translates to "one of the many ways in which the West benefits from the hardwork of the people in the east." Can you clarify that more? Also, can you clarify why the wars in Iraq and Syria (especially Syria) are related to "effort[s] to offend [the] World Bank"? At this point, the answer reads like a rant against financial institutions that isn't supported by facts. – John Bensin Jul 30 '13 at 17:42
  • Apart from your first 2 lines, most of the other stuff is incorrect. Developing economies are marked by Faster growth rate, higher inflation. If the inflation is high, the deopsits rate has to match that and results in higher leanding rate. While developed countries are marked by lower inflation and hence lower deposits and lending rates. The loans provided by World Bank and IMF to developing countries are at favourable rates and terms. – Dheer Jul 31 '13 at 4:10
  • @Dheer Plus, looking at the data, the IMF hasn't loaned anything to India in years, and the level of World Bank loans and grants is only $93B, which isn't much compared to India's total economy of around $2 trillion. I'm also skeptical that countries would go to war with India over World Bank loans... – John Bensin Jul 31 '13 at 13:07
  • @JohnBensin. Agreed. India has not taken a loan for quite some time. If my knowledge is correct, there is some small repayment to be made for the loan taken in 1995's at a very nominal rate. Currently India is resisting taking loan to shore up the steep fall in currency. And no country is going to attack India just because India did not take loan from IMF or world Bank.:) – Dheer Aug 1 '13 at 4:37

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