What affects term deposit interest rates?

William Jolly By on January 28, 2019
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What effects term deposit interest rates

While term deposit interest rates are fixed over the course of your term, banks can still change the rates they offer on new deposits and rollovers. Understand the internal and external factors that influence these movements.

Term deposits remain a popular investment vehicle in Australia, and it’s not hard to see why. They might not be the flashiest of investment options, but they’re simple and secure, which, amid economic uncertainty, is something a lot of people value most.

By depositing a lump sum of money with a trusted financial institution, you receive a fixed rate of interest over a fixed term. This fixed rate doesn’t change after you’ve made the deposit, which can be a huge bonus if markets tank and overall interest rates decline.

There are dozens and dozens of ADIs (authorised deposit-taking institutions) that often offer a wide range of term deposits with different terms, features and, most importantly, interest rates.

The interest rates that ADIs offer on term deposits are typically influenced by a range of internal and external factors, which we’ll explore below.

External factors

Three major external factors affecting how term deposit interest rates are set include:

  • The cash rate
  • Market competition
  • Banking regulations

Official cash rate explained

The cash rate, presided over by the Reserve Bank of Australia (RBA), is perhaps the biggest influence on term deposit rates across the whole market. It is the rate commercial banks borrow and lend to each other at on an overnight basis, influencing the rates on consumer finance products including home loans, savings accounts and yes, term deposits. As such, the cash rate is a benchmark rate for Australian financial institutions and can act as a lever for the RBA to influence economic activity.

When the RBA moves the cash rate, interest rates on deposits and loans generally follow suit. As at January 2019, the cash rate is at a record low of 1.50% and has been at this rate for more than two years. The last time the cash rate increased was more than eight years ago, and many economists aren’t predicting an increase until at least the end of 2019.

The infographic below shows the relationship between the RBA cash rate, average term deposit interest rate and average savings account interest rate over the last couple of decades. You can see a direct correlation between the declining cash rate and declining interest rates over time.

savings term deposit rates vs cash rate

But banks can and do change term deposit rates even when the cash rate is held steady. Such changes can be driven by the factors explained below.

The competition

Deposits are a vital source of capital for banks, using them to fund various operations, which include providing home loans, car loans and credit cards. Banks want to entice customers to deposit funds with them, which is why they can be quite competitive on interest rates.

If one bank were to raise their term deposit interest rates higher than their competitors, they can attract more term deposit customers – gaining more funding. So when a major bank raises their term deposit interest rates, others often follow.

Regulatory requirements

Australia’s 15 largest banks are required to rely on more stable sources of funding, such as term deposits. This comes from the Net Stable Funding Ratio (NSFR) requirements, released by APRA in late 2016. At the time this was implemented, major banks raised their long-term deposit rates to attract more of this type of funding. Future regulatory changes such as this can impact the rates offered by your term deposit provider.

Internal factors

Banks can also set different interest rates for their different term deposit products based on each of the following:

The investment term

Most providers will offer a host of different term deposits, ranging in length from one month to a maximum of five years. The general rule of term deposits is the longer the term, the higher the interest rate. Institutions want to encourage people to stick around and not withdraw their money, so what better way to do this than with a higher interest rate?

According to the RBA’s Retail Deposit and Investment Rates data, these are the average interest rates of different term deposits from Australia’s five largest banks:

  • One month: 1.40% p.a.
  • Three months: 1.90% p.a.
  • Six months: 2.00% p.a.
  • One year: 2.20% p.a.
  • Three years: 2.45% p.a.

Across all providers (not just the five biggest), the average interest rates are slightly higher, and you can again see the difference between the one month and five-year deposit rates:

average term deposit rates jan 2019

The amount invested

Although not too common, some term deposits give you a higher interest rate if you invest more than a specified minimum amount. The highest possible term deposit rate you can get at the moment (January 2019) is 3.98% p.a, but only if you invest at least $250,000. Bear in mind that this is the maximum amount you’ll be covered for under the government deposit guarantee.

The interest frequency

The average term deposit pays interest at maturity, which is when the term ends. This is the norm for term deposits with a term of one year or less. For longer term deposits, it’s not uncommon for them to pay interest into your account monthly, quarterly, semi-annually or yearly.

But term term deposits with more frequent interest payments often have a lower interest rate than those that pay annually or at maturity.

Whether you last the full term

The interest rate on your term deposit can be reduced if you decide to withdraw before the term ends. This reduction in interest is based on how much of your term has elapsed. Banks generally follow this breakdown:

Percentage of the term elapsedInterest rate reduction
0% to 20%90%
20% to 40%80%
40% to 60%60%
60% to 80%40%
80% to 100%20%

Using the table above, a 3.00% p.a, three-year term deposit would have its interest rate reduced to 1.20% p.a, if you decided to withdraw halfway through.

Early withdrawal penalties can vary between providers, so make sure you read and understand the terms and conditions before you apply.

Savings.com.au’s two cents

The external factors primarily influence what will happen to future interest rates, so focus on these when deciding on a term length. For example, if you think these external forces are going to drive interest rates down in the future, you might consider a longer term deposit, and vice versa.

The internal factors should be considered most when actually choosing between different term deposits. You may, for instance, come across a term deposit that might not offer the highest interest rate across the market, but does have the highest interest rate for the term and interest frequency you’re after.

William Jolly
William Jolly joined Savings.com.au as a Financial Journalist in 2018, after spending two years at financial research and comparison website Canstar. In William's articles, you're likely to find complex financial topics and products broken down into everyday language. He is deeply passionate about improving the financial literacy of Australians and providing them with resources on how to save money in their everyday lives.
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