FALLING INTEREST RATES ON FIXED DEPOSITS

The falling interest rates on fixed deposits (FDs) following the recent rate cuts by the Reserve Bank of India have made them an unattractive investment option for a majority of investors. In fact, lots of leading banks — including the SBI and HDFC are currently offering interest rates between 4 per cent and 6 per cent on their fixed deposits, depending on the investment tenure, which has made them at par with the savings account interest rates offered by many banks — offering very little incentive to investors to park their money in FDs.

However, if you are a risk-averse investor or a senior citizen and can’t think about putting your money in a saving instrument other than an FD, then there is no need to get disappointed. Even if you are not risk-averse and are looking for better returns, thankfully, you can still get better options in FD itself. However, before that, you need to understand the nitty-gritty of interest rates.

In fact, banks need deposits and deposits help banks to provide loans. Therefore, to be able to provide new loans, banks need to keep attracting fresh deposits. To attract fresh deposits, some banks will provide you more interest than other bigger or established banks.

Experts add that one should know that all forms of savings and investments carry risks. To get higher returns, you must take higher risks. Risks are lower at the bigger and well-known banks for a variety of reasons like low NPAs.  Therefore, due to lower risks, those banks offer lower interests.  If a bank was to undergo a moratorium or corrective action, the depositor will not be able to withdraw the deposits for a period of time determined by the RBI.

Getting higher returns on FDs

It is true that a majority of banks are currently offering lower interest rates on their FDs. However, that is not the case with all the banks. In fact, some of them are still offering interest rates as high as 9 per cent.

Another expert adds that the highest FD rates offered by some of the small finance banks and a few private sector banks are about 200-300 bps higher than those offered by PSU banks and most private sector banks.  Hence, those wishing to earn higher interest rates on their bank fixed deposits can consider opening FDs with such small finance and private sector banks.  Here are the details of such banks.

How safe are FDs in small finance banks and private banks

• One should understand that RBI has granted the status of Scheduled Banks to these small finance banks, which brings their depositors under the umbrella of deposit insurance program of DICGC, which is an RBI subsidiary.
• This insurance program protects bank depositors for deposits of up to Rs 5 lakh in each scheduled bank in case a scheduled bank fails to pay back its depositors.
• The cumulative deposits, including those held in savings, current, fixed and recurring deposits, are considered while arriving at the Rs 5 lakh cap.
• Hence, one can conclude that maintaining bank deposits of up to Rs 5 lakh in each of these small finance banks is as safe as keeping deposits with public sector banks and major private sector banks. Also, to reduce the deposit risk to the extent possible, customers can spread their fixed deposits across multiple banks offering high-yield FDs in such a way that their cumulative deposits in each of those banks does not exceed the cap stipulated which is Rs 5 lakh cap.
• Also, it is advised that the deposits can be split across multiple banks. If one is prepared to with some risk, and get higher returns, it is advisable to go with smaller banks, company deposits, small savings schemes, government bonds or even liquid mutual funds after a thorough evaluation of risks, lock-ins and any applicable charges.

Evaluating FD returns

• Some intricacies are involved in evaluating FD returns over the long-term. This is because the returns are fully taxable as per your slab rate unless you are a senior citizen in which case you can get Rs 50,000 from deposit interest tax-free. Also, interest is taxed whether or not you redeem your FD.  Therefore, for practical purposes, you must only look at post-tax returns from your FD.
• To quote an example, let us say Gopal Sharma is 30-years-old. He invests in a 7 per cent FD, which would take approximately 10 years and a few months to double his principal amount (assuming no taxation). However, if Gopal Shrma was in the 30 per cent slab, a 7 per cent FD is returning only 4.2 per cent.  Hence, effectively, his money will double in 17 years assuming a constant rate of return. This is highly unattractive from an investment point of view.
• Hence, if one has wealth creation as his/her goal, it is necessary to look beyond FDs because they are highly tax-inefficient and provide a low rate of return. Small investors gain by investing in suitable mutual fund schemes or even government-backed schemes like EPF and PPF, which provide moderately high tax-free and guaranteed returns.
• Those who possess higher risk appetite can consider ultra-short, short and low-duration debt funds for their short-term goals. These debt funds usually offer higher returns than bank FDs and are also more tax-efficient than FDs for investors who are in the 20 per cent and 30 per cent tax slabs with investment horizons exceeding 3 years.

However, while selecting from these funds, one should avoid those having significant exposure to non-AAA category bonds and other debt papers.