Public sector banks are advocating for this reduction in the lock-in period to make fixed deposits more attractive. This request comes amid reports of slower deposit growth compared to credit expansion in FY24, which has led banks to depend on more expensive Certificates of Deposit (CDs) to fill funding gaps.
Tax Saving FDs
Tax-saving fixed deposits are popular among investors for their dual benefit of guaranteed returns and tax deductions. These FDs are specifically designed to encourage long-term savings by offering tax benefits under Section 80C of the Income Tax Act, 1961. They are available through various banks and have traditionally been seen as a safe investment option.
Deductions Available for Tax Saving FDs as per Income Tax Act
Under Section 80C of the Income Tax Act, individuals can claim a deduction of up to Rs 1.5 lakh on investments in tax-saving fixed deposits. This makes them an attractive option for taxpayers looking to reduce their taxable income while earning a secure return on their investment.
In FY24, aggregate deposits grew by 12.9%, while bank credit increased by 16.3%, highlighting the trend of investors seeking higher returns elsewhere. The proportion of deposits in household gross financial savings decreased from 6.2% of gross national disposable income (GNDI) in FY21 to 4% in FY23, while investments in shares and debentures rose from 0.5% to 0.8%.
Due to the buoyant Indian stock markets, more investors are turning to equities, affecting deposit growth, according to another bank executive. Additionally, data from the Association of Mutual Funds in India (AMFI) indicates that the industry’s assets under management (AUM) more than doubled, from Rs 24.79 lakh crore in April 2019 to Rs 57.26 lakh crore in April 2024.
Banks argue that maintaining a healthy credit-deposit (CD) ratio is essential for economic support and funding large infrastructure projects. Recent data shows the CD ratio has been around 80% since September 2023, up from 75.8% in FY23.
Current Lock-in Period
At present, tax-saving fixed deposits come with a mandatory lock-in period of five years. During this period, investors cannot withdraw the funds, which ensures a stable deposit base for banks but may deter investors seeking more flexible investment options with higher returns.
Credit-Deposit Ratio and Economic Stability
The credit-deposit (CD) ratio is a key indicator of a bank’s financial health and its ability to support economic growth. A healthy credit-deposit (CD) ratio is crucial for economic stability. It reflects a bank’s ability to lend money (credit) based on the deposits it receives. A lower CD ratio can limit a bank’s capacity to fund essential projects and hinder economic growth.
Demand for lower lock-in period
Banks have communicated the slowdown in deposit growth to senior government officials. A senior bank executive suggested that shortening the lock-in period for tax-saving fixed deposits from five years to three years could help. The competition from equities, mutual funds, and tax-saving equity-linked savings schemes (ELSS) with a five-year lock-in period has diverted investors away from fixed deposits.
Conclusion
The proposed reduction in the lock-in period for tax-saving FDs presents a potential solution to the widening credit-deposit gap. By making these deposits more competitive, banks hope to attract new investors and improve their lending capacity, fostering economic activity. However, the final decision on this proposal rests with the government.
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