“Is my fixed deposit with so-and-so company safe?” This query is cropping up often, after the recent default on fixed deposit repayments by Dewan Housing Finance Limited and RBI’s strictures on PMC Bank.

When the going is good, fixed income investors in India are often tempted to seek that extra 1 or 1.5 percentage points in returns by investing in FDs of somewhat obscure entities. But defaults help bring out the true risk appetite of the FD investor, who tends to have zero tolerance for capital losses.

This is why, at PrimeInvestor, our approach to curating a list of fixed deposits is to put safety far ahead of return considerations. Here’s the approach we use to choose our recommended list of FDs.     

Safety first

Regulators have quite a few safeguards in place to ensure that only a select club of entities in India can accept public deposits. The Companies Act allows only companies with a minimum net worth of Rs 100 crore or turnover of Rs 500 crore to accept public deposits. Only 6-month to 36-month FDs are allowed. There are other requirements on maximum deposits allowed to be raised and setting aside sums for deposits falling due. 

RBI has equally stringent rules for NBFCs taking deposits. Only those registered as deposit-taking with RBI can accept deposits.  They need to have investment grade credit ratings (up to BBB), and are only allowed 12 to 60-month tenures. Here again there are restrictions on the amount of deposit that can be raised and how to provide for the outstanding deposits. There’s also an interest rate cap of 12.5 per cent.

Despite these elaborate rules though, corporate and NBFC FDs in India have seen quite a few cases of delayed repayments and defaults, from Unitech and Jaiprakash Associates in the past to the recent case of DHFL. In the case of default by a deposit-taking entity, depositors usually have limited recourse because FDs are unsecured borrowings that rank below the secured loans taken by a company.

The safety of your FD money therefore relies mainly on the quality of management of the entity you’re investing with. We look for a reputed industrial name which is in a sound financial position and has an uninterrupted track record of servicing FDs across a complete economic cycle, even if it means foregoing a percentage point or two in returns. The lack of a long enough track record was the reason why we left small finance bank in India out of our current recommended list, despite their attractive rates.    

Sufficient spreads

When you have very safe investments available on tap, it doesn’t make sense to skip them in favour of riskier products unless the latter offer sufficiently high returns. This is why we believe that Indian investors looking for deposit products should choose them mainly on the basis of the spreads (higher rates) they offer over the small savings schemes. Given that India Post’s small savings schemes represent Central government borrowings, they are the safest instruments in the economy.

Recently, while rates on bank deposits have tumbled, interest rates on India Post’s National Savings Time Deposit (post office deposits) have been retained at relatively attractive levels of 6.9 per cent for 1-3 years and 7.7 per cent for 5 years (for October 1- December 31 2019 quarter). In the one-year bucket, FD options from some high quality NBFCs such as Sundaram Finance and HDFC offer just a 0.15-0.25 percentage point spread over National Savings Deposits. We think this is quite thin and therefore recommend that if you need one-year deposits, it is best to maximise deposits in National Savings Time Deposits, despite their inconvenience compared to private or bank FDs.

In the 2 to 3-year buckets, FDs from quality NBFCs offer better spreads of 0.60-1.45 percentage points over National Savings Deposits, making them more attractive parking grounds.

For terms of 5 years plus, investing with NBFCs or companies can be a riskier proposition, given that it is hard to gauge their profit or cash flows over that long. Here, the National Savings Deposit and the National Savings Monthly Income Scheme (POMIS) should again be your preferred options offering 7.7 and 7.6 percent currently. For senior citizens, the post office Senior Citizen’s Savings Scheme with its mouth-watering return of 8.6 per cent is by far the best choice. Seniors must look to other options only after investing the maximum of Rs 15 lakh in this scheme. 

Early exit option

The experience with FD defaults suggests that the biggest risk that FD investors face is a sharp deterioration in the finances, liquidity position or ratings of a company after they’ve locked into their FD. The DHFL case has shown that even firms or NBFCs that start out with AAA ratings can quickly slide to D, once their liquidity situation starts going downhill.

​At PrimeInvestor, we plan to keep a close watch on our recommended list of FDs and recommend premature exits if the risks associated with the entity are spiking up. ​

In the DHFL case, investors who were closely monitoring the news flow on the company have managed to save their capital by seeking early closure of their FDs with the NBFC, which honoured such dues until October.  

This makes it important for FD investors to track the credit ratings and financial positions of the companies whose FDs they’ve invested in, throughout their investment period. They should also be prepared to pull the trigger on their deposits and exit early, irrespective of the penalties levied.

At PrimeInvestor, we plan to keep a close watch on our recommended list of FDs and recommend premature exits if the risks associated with the entity are spiking up.  

Full disclosure

To gauge if a deposit-taking entity is facing new threats to its finances or liquidity, regular public disclosures of its finances are a must-have. Today, such high-frequency disclosures are available only from listed entities in India. With unlisted entities, not only would you have no idea of how it is faring on a quarterly basis, even the annual results are filed after a considerable lag. This lack of disclosures makes us avoid corporate FDs from unlisted entities as well as deposits with co-operative banks completely, no matter how good their rates.

Many investors ask if the fixed deposit programmes of State government entities offering high rates make for good investments. As sovereign entities, such deposits, on paper, are safer than corporate FDs. But in practise, the poor state of finances of many State governments and the lack of timely information about State government finances make them opaque bets that we would rather avoid. 

Currently, deposit-taking NBFCs score over deposit-taking companies on the disclosure front, given that the RBI has mandated detailed public disclosures. This enhances our comfort level with NBFCs as compared to corporate FDs, despite the former’s riskier operations.

So, do look out for PrimeInvestor’s recommended list of deposits. Through this list, you will not only get the curated list of deposits but also be alerted on any developments that warrant action on your deposit holdings. Finally, no matter how much due diligence we put into vetting any investment, we cannot completely avoid the risk of it going wrong due to sudden events overtaking us. The only way to address this risk is for you to diversify your investments across multiple options within an asset class. This holds good for deposits too.