Banks earn their revenue primarily by sourcing their funds at a lower cost and offering loans at a higher rate. The difference is their profits. To do so they must accept deposits and lend in the form of loans to borrowers.
Fixed deposits are one of the ways banks source their funds. One of the advantages of fixed deposits are that they come with a predefined term. The bank essentially pays the depositor an interest in order to be able to use those funds for a definite and particular term. Most banks therefore charge a penal interest if the depositor wants to encash his FD prematurely.
Reasons why banks don’t offer flexible FDs
- Not to encourage premature withdrawals: By definition, a fixed deposit entails parking of the funds in the bank for a pre-set term. To break it prematurely entails that the bank must arrange those funds from elsewhere in order to pay the depositor. Hence banks charge a penal interest to the depositor.
- Cost of funds goes up: If the bank arranges funds to pay the investor prematurely, then it may not have the same cost as what the bank was paying the depositor. Banks therefore do not offer premature withdrawal facilities by default, and do so on a case-to-case basis.
- Depositors might fall back on FDs in case of need: Unless the concept of penal interest is there to discourage premature withdrawals, there is a chance that depositors may fall back on FDS as and when they need funds and the purpose of saving for the long run is defeated.
- Premature withdrawals take up time and resources: By allowing flexibility in withdrawals, banks also risk more transactions from depositors who wish to make premature withdrawals from their FDs. This is likely to hold up precious time and resources of the bank and add to their transactions. This is why flexible deposits are not allowed.
These are few of the reasons why banks do not offer flexible FDs by default. To break a term deposit prematurely, the customer must approach the branch and agree to pay the penal interest/charges and only then allowed to make a premature withdrawals.