Strategize your FD investments as rates drop

Since February 2019, the Reserve Bank of India (RBI) has reduced the benchmark repo rate by 75 basis points. Accordingly, banks too have been gradually reducing the interest rates they offer on their deposits, especially fixed deposits (FDs). However, the reduction in FD rates by banks has not been in sync with the fall in repo rates. Between February and June, State Bank of India (SBI) reduced the interest rate offered on its FDs below ₹2 crore for a tenor of five years and above from 6.85% to 6.60%, a reduction of only 25 basis points.

But why are deposit rates reducing at a slow pace? This behaviour is not typical of banks. In the past, it has been observed and recorded that banks reduce deposit rates swiftly in a falling rate regime, while not being equally quick to raise deposit rates when the benchmark rates go up.

Banks use the money collected through deposits to give loans. The growth in loans has been faster than the growth in deposits in the last few quarters. To feed the growth and demand of credit, banks need the money from depositors and, hence, are not reducing deposit rates in line with the fall in repo rate. However, with RBI taking additional measures to address the liquidity concern of banks, the rates will eventually fall further.

What should you do? While falling rates are good for borrowers, depositors have to be content with lower returns in such a scenario. FDs are a preferred mode of investment for retail investors who want the highest level of safety for their principal amount as well as guaranteed returns.

In case of falling rates, if your investment horizon is medium to long term, it makes sense to lock into a long-term FD now, said Prakash Praharaj, founder, Max Secure Financial Planners, a financial planning firm. “All indicators including RBI’s accommodative stance in the monetary policy suggest that FD rates will go down further,” he said.

However, financial planners advise you to not put the entire corpus in a single instrument and maintain your asset allocation. For your debt allocation, the choice often is between FDs and debt funds. It makes sense to opt for a combination of both. Going for only one of the two is not advisable. “Money required within a year can go to flexi FDs that allow mid-term withdrawal. The amount required between two and three years can go into FDs. But beyond that, the investor should consider corporate bond funds or banking and PSU debt funds that have no credit risk,” Praharaj said.

Investors not willing to invest in debt funds may find fixed deposits from small finance banks more attractive, but they should know the risks involved. For instance, some small finance banks’ FD rates for senior citizens could be as high as 9%, which is almost 2% higher than SBI’s FD rate for a five-year FD. While these small finance banks are regulated by RBI and are also covered under the Deposit Insurance and Credit Guarantee Corp. (DICGC), that gives an insurance to deposits of up to ₹1 lakh, experts advise caution.

Banking analysts as well as financial advisers are not yet completely sure about their credit practices and their assets and liabilities management is yet to be proven for a prolonged period of time.

Melvin Joseph, a Sebi-registered investment adviser and founder of Finvin Financial Planners, a financial planning firm, said that retail investors should keep in mind that risk can be taken in equity, but not in debt, and given the ongoing situation in non-banking financial companies, investors should stick to traditional large banks with strong balance sheets. “If someone wants to invest say ₹30 lakh in debt after (exhausting their) EPF (Employees’ Provident Fund) and PPF (Public Provident Fund), I would go for a 50:50 split between FDs and debt funds. From the ₹15 lakh that will go into FDs, no more than ₹1-2 lakh should go to these new small finance banks. One must remember that for their debt portion, return of capital is more important than return on capital,” Joseph said.

Also, when strategizing your FD investments, remember to look at your asset allocation and align your investments with your financial goals.