Banks have once again begun levying a penalty on customers for pre-closure of their term deposits. In some cases, this is an anticipatory move, given that customers are closing their existing term deposits with the intention of redeploying them in higher yielding deposits. This is happening as interest rates are being hiked by banks to mop up funds before the year-end.

Banks are allowed by the regulator, the Reserve Bank of India, to levy pre-closure penalty. To facilitate better asset-liability management, the RBI, in April 2010, in a review of its earlier guidelines, allowed banks to formulate their own policies in this regard.

Penalty for pre-closure

HDFC Bank has implemented this clause for all pre-closure of deposits with effect from January 24. HDFC Bank states on its Web site that the penalty on premature closure of FDs, including sweep-in and partial closure, will be 1 per cent. For instance, if you have deposited money at 8 per cent interest for one year and opted to pre-close after 10 months. If the interest for the 10-month period is 7 per cent, the bank will reduce 1 per cent and pay you interest at the rate of 6 per cent for the appropriate number of days.

Similarly, the country's top bank, SBI levies a penalty at the rate of 1 per cent below the rate applicable for the period that the deposit has remained with the bank. Karur Vysya Bank levies a penalty of 1 per cent on pre-closure of all deposits. However, a branch official said that if the pre-closure proceeds are redeployed with it, waiver of the penalty may be considered.

To pre-close, or not?

So, should you close your deposits when there is a pre-closure penalty? That depends on how long you have held the deposit and the new rates, of course. But you can think about it if there is still some time before the deposit matures. Consider this: If you have a three-year deposit of Rs 3 lakh at 8 per cent interest, and you hold the deposit till maturity, you will receive Rs 3.78 lakh. But if you pre-close the deposit after holding the deposit for seven months, your loss will be Rs 4,375 (considering an interest rate of 6.5 per cent and a penalty of 1 per cent). But by deploying the pre-closure proceeds at 10 per cent interest for the remaining two years and five months, you gain Rs 5,400. So it may be prudent to close your deposit and enjoy the extra income from higher rates.