How do Banks Calculate Interest on Savings accounts & FD in India?

A Savings Account offers interest on the balance maintained in it. However, we use these accounts for regular transactions. How does the bank calculate interest? What balance does the bank consider? Also, if you are opening a Fixed Deposit account and decide to withdraw your funds prematurely, then how does the calculation work? 

While computers do most of the heavy lifting in terms of interest calculations, it is important to understand these calculations to know the returns you are getting.

Savings Account Interest Calculation

Interest calculation on Savings Accounts has become much simpler after 2010. 

Pre-2010

Very few people know that earlier, banks would calculate interest on the lowest balance held between the 10th and the last day of the month. So, if your account had a minimum balance of Rs.1000 during the said period, then the bank calculated interest for the month on Rs.1000 only, regardless of how much balance you had in the rest of the month.

In 2009, the RBI released a circular mandating all banks to calculate interest on a daily product basis as opposed to the methodology followed earlier. 

Post-2010

Today, the interest on a Savings Account is calculated as follows:

Savings Account Interest = Daily Balance × Rate of Interest × Number of Days365 ×100

Let’s understand the calculation of how banks calculate interest on savings accounts in India with the help of an example:

Rajeev has a Savings Account with a bank that offers an interest rate of 4% per annum. Here is a look at his account in May 2022.

The interest calculation is done as follows:

• Closing balance from 01st to 5th May = Rs.200,000. 

The number of days = 5.

Therefore,

Savings Account Interest for these 5 days=200000 ×4 ×5365 ×100=Rs.109.59

• Closing balance from 06 to 09 May = Rs.140,000.

Number of days = 4

Therefore,

Savings Account Interest for these 4 days=140000 ×4 ×4365 ×100=Rs. 61.37

• Closing balance from 10 to 19 May = Rs.180,000

Number of days = 10

Therefore,

Savings Account Interest for these 10 days =180000 ×4 ×10365 ×100=Rs. 197.26

• Closing balance from 20 to 31 May = Rs.195,000.

Number of days = 12

Therefore,

Savings Account Interest for these 12 days=195000 ×4 ×12365 ×100=Rs. 256.44

Here is a summary:

Hence the total interest earned in May 2022 is Rs 624.66

While the interest is calculated daily, it is credited to the depositor’s account only every three or six months based on the bank’s policy.

Fixed Deposit Interest Calculation

Calculation of interest on Fixed Deposits is relatively simpler if they are held until maturity. However, if you prematurely withdraw the FD, then the bank can levy a penal interest. Let’s understand these interest calculations with the help of an example.

Rajeev opens a Fixed Deposit for Rs.200,000 for a period of one year. The rate of interest offered by the bank is 8% per annum. On the same day, the rate of interest for a six-month deposit was 6%. Also, in the event of a premature withdrawal of FD, the bank charges 0.5% as a penalty.

Scenario 1: Rajeev holds the FD until maturity

The interest earned by an FD is calculated as follows:

FD Interest=Principal ×Rate of Interest ×Number of Days365 ×100

The details of Rajeev’s FD are as follows:

• Principal = Rs.200,000
• Rate of Interest = 8% per annum
• Tenure of holding = 1 year (365 days)

Therefore, the interest earned by Rajeev on the FD will be:

FD Interest=200000 ×8 ×365365 ×100=Rs. 16,000

On maturity of the FD, Rajeev will receive Rs.216,000 pre-taxes.

Scenario 2: Rajeev breaks his FD after 6 months

In this case, the interest calculation changes.

Since Rajeev had booked the FD for one year, the bank had offered a rate of interest of 8% per annum. However, it is important to remember that while Rajeev had booked the FD at 8% p.a. since he decides to withdraw it prematurely, the bank will not pay interest at 8% p.a. for six months. Instead, it will pay interest applicable for a six-month deposit. In this case, the interest rate for a six-month deposit was 6%. 

Further, the bank will charge a penal interest of 0.5% on premature withdrawals. Therefore, the effective interest rate will be 

Effective rate of interest = 6-0.5 = 5.5%

Therefore, the bank will calculate interest as follows:

FD Interest=200000 ×5.5100=Rs. 11,000

On maturity of the FD, Rajeev will receive Rs.211,000 pre-taxes.

Also, check out the FD Interest rate calculator if you are planning to invest in FD.

Summing Up

So this was all about how banks calculate interest on savings accounts and fixed deposits.

While most investors rely on the bank to calculate interest efficiently, it is important to understand the calculation to have a complete grip over your deposits. There are many online calculators that can help you find the interest on your Savings or Fixed Deposit Accounts.