Grappling with fear of Covid-19: Flight to safety as investors move to FDs

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Published: May 20, 2020 3:00:48 AM

While the higher interest rates on company deposits are tempting, remember these are unsecured loans. Repayment of principal and interest are not guaranteed. In case of any default or delay, investors have little recourse

For one to three years tenure, the rate has been cut to 5.5% from 5.7%. For one to three years tenure, the rate has been cut to 5.5% from 5.7%.

Risk-averse investors are moving money to fixed deposits of state-owned banks and top rated finance companies as the stock market remains volatile and debt funds, too, have become riskier after Franklin Templeton closed six of its credit risk fixed income schemes because of redemption pressure and illiquidity caused by the Covid-19 pandemic. Investors may get payments in a staggered manner if the fund house is able to recover money after liquidating the investments.

Panic-stuck debt fund investors have rushed to redeem their investments in credit risk funds of asset management companies, which reported a net outflow of Rs 19, 239 crore in April. This indicates that investors are no longer willing to take risks in the debt portion of their portfolio.

Bank deposits gain
Bank deposits grew by 9.8% year-on-year to Rs 137.10 lakh crore till April 24 according to data from Reserve Bank of India (RBI). This comes at a time when banks are reducing interest rates on deposits. For instance, the country’s largest lender, State Bank of India, has cut fixed deposits (FD) rates for the third time in two months. From May 12, interest rates on FD for up to three years have been cut by 20 basis points. For one to three years tenure, the rate has been cut to 5.5% from 5.7%. However, the rate for deposits above three years remains unchanged at 5.7%.

Moreover, the bank has introduced a new product called SBI Wecare Deposit for senior citizens, where an additional 30 bps premium will be payable for deposits with five years and above. This scheme would be in effect up to September 30, 2020. So, the new product for senior citizens will earn 80 bps higher than the rate applicable for the general public. This additional premium will not be payable in case of premature withdrawal of such deposits.

The RBI has increased insurance cover on bank deposits from Rs 1 lakh to Rs 5 lakh to provide a greater measure of protection to depositors. The cover, which was Rs 1 lakh since 1993, is provided by the Deposit Insurance and Credit Guarantee Corporation, a wholly-owned subsidiary of the RBI. The increase in deposit insurance will help boost the confidence of people in the banking system as the scheme covers all banks operating in India, including the private sector, cooperative and even branches of foreign banks.

Company deposits: Understand the risks
Even fixed deposits of top-rated finance companies such as Bajaj Finance or HDFC are in demand as they offer higher interest than bank deposits. For example, ICICI Home Finance is offering interest rate of 7.6% (cumulative) on fixed deposits for 108 to 120 months and senior citizens will get an additional 0.25% interest rate on their deposits. Similarly, Bajaj Finance is offering 7.6% (cumulative) for 5-year deposits.

While it may be tempting to invest in company deposits for higher interest rates, investors must understand the risks before investing in them. In fact, bank term deposits are safer than company deposits because they are governed by stricter regulations of the RBI. Company deposits may default on payment of interest and even the principal amount as was seen with Dewan Housing Finance Ltd and a host of real estate companies in the past.

Company fixed deposits are unsecured loans, where repayment of principal and interest are not guaranteed. In case of any default or delay, investors have little recourse.

An investor must analyse the financial statements, performance of the company and its management to take an informed decision before investing in company deposits. One must invest only in a company with a high credit rating—AAA or at least AA—assigned to an instrument by a credit rating agency such as CARE, Crisil, ICRA, etc. During the period of investment, if the credit rating of the deposit falls, one must withdraw the money even if it requires paying a penalty for premature withdrawal.

Also, remember that interest earned from both bank fixed deposits and company deposits are taxed according to the income tax slab of the investor.

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