A bank will pay noticeably more for a deposit locked away for a year than for the same amount available on demand. The difference is not a reward for patience but a price for certainty.
Banks borrow short and lend long
Deposits are typically repayable quickly while loans, particularly mortgages, run for years. That mismatch is the core function and the core risk of banking.
A bank funded entirely by instant access money is exposed to the possibility that funding leaves faster than assets can be sold or repaid.
Deposits with a fixed term reduce that exposure, because the bank knows precisely how long the money will remain and can match it against assets of a similar length.
That matching is what allows a bank to commit to lending for years without relying on the assumption that today's instant access balances will still be there tomorrow.
Regulation puts a number on the difference
Liquidity rules require banks to hold buffers of high-quality assets against the possibility of deposits leaving under stress.
Those rules assume different outflow rates for different deposit types, with stable retail balances treated more favourably than money that can vanish overnight.
Because a term deposit generates a smaller assumed outflow, it requires a smaller buffer, and the saved cost is what funds the higher rate.
The saver is selling an option
Instant access means the depositor can withdraw whenever conditions favour doing so, including when rates rise and better opportunities appear.
Committing to a term surrenders that flexibility, and the higher rate is the compensation for giving it up.
Viewed this way the premium is a price rather than a bonus, and whether it is adequate depends on how likely rates are to move during the term.
Early withdrawal terms define the real product
Most term deposits permit early access with a penalty, usually expressed as a forfeit of a period's interest.
The size of that penalty determines how binding the commitment actually is, and it varies enough between products to matter more than small rate differences.
Where no early access is permitted at all, the deposit should be treated as genuinely unavailable, which changes what role it can play in a household's arrangements.
The yield curve sets the shape
Longer terms usually pay more, reflecting the additional certainty and the general tendency for longer commitments to earn more.
That relationship inverts periodically, and when short terms pay more than long ones, the market is signalling an expectation that rates will fall.
Laddering across several maturities is the common response, since it provides regular access to a portion of the money without committing everything to one view.