Fixed deposits (FDs) have been a preferred choice for Indian investors seeking secure and guaranteed returns. While banks have traditionally been the go-to institutions for FDs, Non-Banking Financial Companies (NBFCs) have emerged as an alternative, often offering the highest interest on FD. However, the decision to invest in an FD with a bank or an NBFC should be guided by an understanding of the associated risks and benefits. Tools like the LIC fixed deposit apphave made investing in NBFC FDs more accessible, but it’s crucial to evaluate the safety and returns before making a choice. This article explores the risks involved in fixed deposit schemes with NBFCs compared to banks, providing insights to help investors make informed decisions.
Understanding the difference between NBFCs and banks
Banks are regulated by the Reserve Bank of India (RBI) under the Banking Regulation Act, offering a wide range of financial services, including savings accounts, loans, and fixed deposits. NBFCs, on the other hand, are financial institutions providing similar services but are governed by the Companies Act and regulated by the RBI with specific guidelines. While both offer fixed deposit schemes, the level of regulatory oversight and safety mechanisms differs significantly.
Key risks of fixed deposits in NBFCs
1. Lack of DICGC insurance
Bank deposits, including FDs, are insured up to ₹5 lakh per depositor under the Deposit Insurance and Credit Guarantee Corporation (DICGC). This insurance provides a safety net in case the bank fails. NBFC deposits, however, do not come with this insurance coverage, increasing the risk for investors in the event of an NBFC’s financial distress.
2. Higher default risk
NBFCs generally carry a higher risk of default compared to banks due to their relatively lower capital reserves and dependence on market borrowings. While they may offer the highest interest on FD to attract investors, the safety of the principal amount can be a concern.
3. Regulatory differences
Banks are subject to stricter regulatory scrutiny and capital adequacy requirements, ensuring greater financial stability. NBFCs operate under less stringent regulations, which could expose investors to higher risks during economic downturns or liquidity crises.
4. Limited liquidity options
Some NBFCs may have restrictive terms for premature withdrawals or may impose higher penalties, reducing the overall flexibility and liquidity of your investment.
5. Market sensitivity
NBFCs are more sensitive to market conditions, making their financial stability susceptible to economic volatility. This could impact their ability to honour fixed deposit commitments.
Key risks of fixed deposits in banks
1. Lower interest rates
Compared to NBFCs, banks generally offer lower interest rates on fixed deposits. Investors seeking the highest interest on FD may find bank deposits less appealing in terms of returns.
2. Limited flexibility in rates
Banks are highly regulated, which restricts their ability to offer customised or significantly higher interest rates, even for long-term deposits. This could limit the potential growth of your investment.
3. Systemic risks
Although banks are considered safer, they are not entirely immune to risks. Events like financial scandals or economic crises could impact their stability, though the risk is generally mitigated by government and RBI interventions.
Comparing fixed deposits in NBFCs and banks
1. Interest rates
NBFCs often provide the highest interest on FD, making them attractive for investors seeking higher returns. For instance, interest rates on FDs offered through platforms like the LIC fixed deposit app are usually higher than those of traditional banks. However, the higher returns come with increased risks, making it essential to balance returns with safety.
2. Safety and security
Bank FDs are widely regarded as safer due to DICGC insurance and stringent regulations. NBFC FDs, while offering better returns, lack this level of security, making them a riskier option for conservative investors.
3. Tenure flexibility
Both banks and NBFCs offer a range of tenures, but NBFCs may have more flexible options to attract different types of investors. However, premature withdrawal terms can be stricter with NBFCs.
4. Credibility and ratings
Credit ratings assigned by agencies like CRISIL, ICRA, and CARE are crucial indicators of an institution’s financial health. While banks generally have higher credit ratings, investors must carefully review the ratings of NBFCs before investing in their FDs.
How to minimise risks when investing in NBFC FDs?
1. Check credit ratings
Always choose NBFCs with high credit ratings, which indicate lower default risk. For example, an AAA-rated NBFC is considered financially stable and reliable.
2. Diversify investments
Avoid putting all your savings into a single FD, whether with a bank or an NBFC. Diversify across multiple institutions to spread risk and ensure better safety of your funds.
3. Monitor liquidity needs
Evaluate the terms and conditions for premature withdrawal. Opt for NBFCs or banks that offer flexibility in accessing your funds without high penalties.
4. Use digital tools
Digital platforms like the LIC fixed deposit app enable investors to compare interest rates, check institution ratings, and track their investments seamlessly. Utilising these tools ensures informed decision-making.
5. Stay updated on regulations
Keep track of regulatory changes and news related to the banking and NBFC sectors. Understanding the financial health of your chosen institution helps mitigate potential risks.
Tax implications on fixed deposits
Interest earned on FDs, whether with banks or NBFCs, is taxable under the Income Tax Act. The interest is added to your total income and taxed according to your applicable tax slab. If the total interest exceeds ₹40,000 in a financial year (₹50,000 for senior citizens), Tax Deducted at Source (TDS) is applicable.
To optimise post-tax returns, consider investing in tax-saving FDs offered by banks. These FDs have a lock-in period of five years and qualify for deductions under Section 80C of the Income Tax Act. However, keep in mind that interest earned on these FDs is still taxable.
Why NBFC FDs remain attractive despite risks?
Despite the associated risks, NBFC FDs continue to attract investors due to their higher interest rates. For those with a higher risk appetite, NBFC FDs can be a lucrative option, especially for short- to medium-term goals. Schemes like those offered through the LIC fixed deposit app provide competitive rates and flexible tenure options, making them a viable alternative to bank FDs.
Conclusion
Fixed deposits remain a cornerstone of financial planning for Indian investors, offering safety, stability, and predictable returns. While bank FDs are widely regarded as safer due to regulatory oversight and DICGC insurance, NBFC FDs provide the highest interest on FD, making them an attractive option for risk-tolerant investors. Tools like the LIC fixed deposit app have made it easier to access and manage these schemes, but it’s crucial to weigh the risks and benefits carefully. By evaluating credit ratings, diversifying investments, and understanding the tax implications, you can make informed decisions and optimise your fixed deposit investments, whether with banks or NBFCs. Balancing safety with returns ensures that your financial goals are met while minimising potential risks.