Theoretical Statistics and Mathematics Unit, ISI Delhi

Rate of interest on term deposits -- A micro level study

by Ashish Das and Praggya Das

Public savings in the Banking System are of prime importance to dictate the economy
of India. A major component of such savings is through Time deposits constituting nearly
85\% of the Total deposits. Furthermore, Term deposits constitute a major component of
such Time deposits. Considering all scheduled commercial banks of India, Time deposits
are in the order of Rs. 830,000 crores and are growing at more than 17\% every financial
year. The interest amount paid on the Time deposits directly depends not only on the
rate of interest applicable to such deposits but also on a number of other factors, including
the method used to calculate the same. Though there has been a lot of discussion in the
literature on the quantum of the rate of interest, there appear to be no discussions on
the method of calculating such interests. This could be because it was thought that the
method of calculation should have one and only one meaning. In this paper, we discuss the
mathematics of rate of interest and give several different methods of calculating the interest
amount. Although not an exhaustive list, the methods of calculating interest described here
are some of the more common methods in use. They indicate that the method of interest
calculation can substantially affect the amount of interest paid, and that depositors should be
aware not only of nominal interest rates but also of how nominal rates are used in calculating
total interest amount. Moreover, since the depositors constitute 89\% of bank customers, in
the interest of customer protection as also to bring about meaningful competition we observe
that it is necessary to have a greater degree of transparency in regards to effective interest
rates for depositors.

isid/ms/2002/13 [fulltext]

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