Term deposits with banks are a favoured investment option in India due to their provision of a fixed interest rate for a predetermined period, ensuring a relatively secure investment experience. Investors can confidently anticipate their earnings and when they will receive them.
The safety of term deposits can be attributed to two key factors:
Deposit Insurance: In India, term deposits held with banks are safeguarded by the Deposit Insurance and Credit Guarantee Corporation (DICGC), providing coverage of up to ₹5 lakh per depositor per bank. This means that even if a bank faces insolvency, depositors will still receive their money, up to this limit.
Statutory Liquidity Ratio (SLR): Indian banks are obliged to maintain a specified percentage of their deposits in government securities as part of their Statutory Liquidity Ratio (SLR). This requirement ensures that banks possess sufficient liquid assets to meet their obligations to depositors.
Safety of term deposits with corporates
While term deposits can also be placed with corporate entities, these deposits lack DICGC insurance and therefore carry a lower degree of security compared to bank deposits. Corporates typically offer higher interest rates to attract investors, but potential investors should be cautious about the increased risk associated with corporate investments. It is advisable to carefully assess the financial stability of the corporation and its track record in meeting financial obligations before investing.
Assessing investments using SLR
The SLR framework, encompassing safety, liquidity, and returns, serves as a useful tool for evaluating the risk and return potential of different investments:
Safety: The SLR evaluates the safety of an investment by considering factors such as the issuer’s creditworthiness and the level of government backing.
Liquidity: SLR assesses the liquidity of an investment by gauging how easily it can be converted into cash.
Returns: SLR takes into account the returns potential of an investment by examining the interest rate or dividend yield it offers.
Term deposits fare relatively well in terms of SLR assessment because of their DICGC insurance and fixed interest rates. However, it’s important to note that term deposits tend to have lower liquidity compared to some other investments like savings accounts and money market funds.
Additional aspects of deposit safety
Apart from the factors mentioned above, there are other considerations for investors when evaluating the safety of term deposits.
Choose reputable institutions: Investors should select established banks and corporations with strong track records when placing term deposits.
Diversify your portfolio: To mitigate risk, investors should diversify their investments across various asset classes, including term deposits, stocks, bonds, and real estate.
Carefully review terms and conditions: Before investing in a term deposit, it’s crucial to thoroughly review the fine print to understand the deposit’s terms and conditions, including interest rates, maturity dates, and any penalties for early withdrawal.
Revisiting the safety factor at private banks
There is not much safety issue when it comes to depositing your money in public sector banks. However, investors must be careful when they invest in fixed deposits issued by private banks. Some private banks are too big to fail. However, you must be careful of the small and peripheral ones.
Diversifying your deposits is a prudent strategy, particularly when dealing with relatively smaller private sector banks. This approach serves to mitigate your risk in the event of a bank failure. Additionally, it’s crucial to ascertain DICGC coverage. DICGC, a government-backed entity, provides insurance for deposits up to ₹5 lakh per depositor per bank. This safety net ensures that even if the bank were to falter, you would still recover your funds, subject to this limit.
Historically, the Reserve Bank of India (RBI) has intervened by merging troubled banks with stronger or larger institutions to safeguard depositors. However, it’s important to recognise that this isn’t always a viable solution. When a bank faces severe financial distress, merging may not be possible, potentially resulting in depositors losing a portion or all of their savings.
Therefore, a prudent approach involves diversifying your deposits across multiple banks with solid track records. Moreover, verifying DICGC coverage is essential to confirm the safeguarding of your deposits. Here are additional tips to enhance the security of your deposits:
- Exercise caution with banks offering exceptionally high interest rates, as this can indicate financial instability.
- Stay informed about the financial health of your bank by reviewing their annual reports and financial statements.
- Be vigilant for any negative news or reports concerning the bank’s stability.
- If you have concerns regarding the bank’s safety, consider reaching out to the RBI for guidance and clarification.
Are cooperative banks safe?
Cooperative banks differ in risk profiles when compared to small finance banks. Small finance banks represent a relatively recent addition to India's banking landscape, still in the process of building their financial infrastructure and refining risk management systems. In contrast, cooperative banks boast a longer history and a wealth of banking experience.
Nonetheless, it remains imperative to verify DICGC coverage and diversify your deposits when considering investments in cooperative banks. This precautionary measure is necessary because even cooperative banks can face adversity, and DICGC insurance extends protection to your deposits, covering up to Rs. 5 lakh per depositor per bank.
Furthermore, conducting a thorough examination of the fundamental aspects of any cooperative bank before investing is a prudent practice. This includes scrutinising the bank's financial statements, credit ratings, and any adverse news reports concerning the institution.
Here are additional pointers to assist you in assessing the safety of a cooperative bank:
- Explore the bank's website to ascertain its membership in organisations such as the National Federation of Urban Cooperative Banks & Credit Societies (NAFCUB) or the National Cooperative Union of India (NCUI). These entities establish standards for cooperative banks and offer support to their members.
- Analyse the bank's financial statements to gauge its performance. Pay particular attention to metrics like the capital adequacy ratio, non-performing assets ratio, and return on equity.
- Investigate the bank's credit rating. A favourable credit rating signifies the bank's financial stability.
- Stay informed about any negative news coverage related to the bank. This can assist in identifying potential issues or challenges facing the institution.
By adhering to these guidelines, you can fortify the protection of your deposits and reduce the potential for financial losses.
Should you buy corporate deposits?
Corporate deposits lack the same explicit and implicit safety measures as traditional bank deposits, which is why they typically offer higher interest rates.
The extent to which corporate deposit rates surpass bank deposit rates sparks debate. Some argue for significantly higher corporate deposit rates to compensate investors for the elevated risk, while others advocate for only marginal differences, given that corporate deposits are still considered relatively secure.
Compared to benchmark institutions, such as leading Public Sector Undertaking (PSU) or private sector banks, corporate deposit rates tend to be higher. For instance, as of September 2023, a prominent PSU bank offers a 7.4 per cent interest rate on a 5-year term deposit, while a leading private sector bank offers 7.6 per cent. Certain corporate deposits even extend interest rates of 8 per cent or more on 5-year term deposits.
However, it's essential to recognise that not all corporate deposits carry the same risk profile. Some are issued by financially robust companies, while others originate from entities with weaker financial histories. Thus, prudent investors must thoroughly assess the financial stability of the company before committing to a corporate deposit.
Here are some guidelines for investing in corporate deposits:
- Focus on corporate deposits offered by financially sound companies with a strong track record.
- Diversify your investment portfolio by considering corporate deposits from a variety of reputable companies.
- Only allocate funds to corporate deposits that you can afford to lose, as they do carry a level of risk.
Deciding on the quality of corporate deposits is not difficult only if you are willing to refer to the following necessary factors. These include:
Credit rating: The credit rating assigned to a corporate deposit reflects the company's ability to meet its debt obligations. The highest rating is typically AAA, followed by AA+, AA, and so forth. A lower credit rating implies a higher risk of default.
Goodwill and pedigree: The goodwill and pedigree of the corporation serve as indicators of its reputation and historical performance. It's advisable to favor companies with strong reputations and a long history of profitability.
Fundamentals: A company's fundamentals encompass its financial health and business prospects. Look for corporations with robust balance sheets, healthy cash flows, and competitive business models.
In addition to these considerations, the following factors should also be taken into account:
Interest rate: Corporate deposits often offer higher interest rates compared to bank deposits. However, it's essential to recognise that this increased yield comes with a heightened level of risk.
Tenure: Corporate deposits are typically available for various tenures, spanning from several months to several years. Investors should align the deposit's tenure with their investment objectives and risk tolerance.
Liquidity: Corporate deposits generally exhibit lower liquidity compared to bank deposits, which may result in greater difficulty when attempting to sell a corporate deposit before its maturity date.
Before investing in corporate deposits, investors should thoroughly evaluate all these factors. Here are some additional tips to enhance the decision-making process:
Familiarity: Invest solely in corporate deposits from companies that you are acquainted with and comprehend.
Research: Conduct independent research on the company before making an investment. This entails reviewing the company's annual reports and financial statements to gain insights into its financial health and performance.
Seek professional advice: Consult a financial advisor before committing to corporate deposits. A financial advisor can help assess your risk tolerance and investment goals, and recommend corporate deposits that align with your financial objectives.
If your investments are within a well-established blue-chip corporate group, your funds are secure. However, it's crucial to take into account factors like liquidity (early withdrawal terms) and the management's track record.
Risk-averse investors usually prefer big bank deposits over fixed deposits issued by small finance banks and corporate houses. Though there is an inherent risk in all of them, the quantum of risk involved is different as much as the interest rates, which is why you must be willing to take care of important factors before deciding to put your money in any one of them.