Should you go for the 4-5-year special deposit schemes from NBFCs now?

With popular NBFCs such as Sundaram Finance, HDFC and Bajaj Finance revising their deposit rates in the past year, FD investors can finally look forward to better returns, after a long drought. Rising demand for loans in an improving economy, is forcing NBFCs to compete actively for deposits once again, prompting even top-rated ones to roll out deposit schemes for longer tenures of 4 to 5 years with ‘special’ rates. Sundaram Home Finance is offering 7.65% on its 4-year FD and HDFC has a special offer of 7.6% running on its 45-month Sapphire Deposit scheme. 

But are these rates special enough for you to lock in your money for longer tenures of 4 or 5 years? 

After analysing trends in interest rates, we think not. We suggest that:

• Investors should stick to shorter tenures of upto 3 years on FDs in general and wait for better deals to emerge on 4-5 year tenors in the months ahead 
• Investors with more than 3-year money should prefer bank FDs or passive debt funds over NBFC FDs. 

Rates rise, but not enough 

As market interest rates have climbed, interest rates on NBFC FDs have moved up too in the last 18 to 24 months. FD schemes from popular deposit-taking NBFCs such as Sundaram Finance and HDFC, which fell by anywhere between 100 and 165 basis points between early 2020 and early 2021, have risen by 110 to 155 basis points between 2021 and now. The table below shows the increase in rates on 1-3 year FDs, between April 2021 and January 2023 on the two most favoured deposit-taking NBFCs. 

NBFCs in slightly riskier businesses such as Bajaj Finance, M&M Finance and Shriram Finance have hiked their FD rates slightly more (150-170 basis points) between April 2021 and now. But while NBFCs have pegged up their rates, the increases have certainly not kept up with the rebound in market rates. In fact, while 1 to 3 year borrowing costs for both banks and companies are now well above pre-Covid levels, rates on NBFC FDs have just about matched pre-Covid levels.

Between April 2021 and now, RBI’s repo rate has risen by 225 basis points, rates on one-year commercial paper (through which top corporates borrow) are up by 348 basis points, AAA rated companies are paying 249 basis points more on their 3-year bonds. Even the government of India is paying 306 basis points more on its treasury bills. NBFCs, even top-rated ones, are clearly riskier entities than all of the above. Yet, their FD rates have moved up by less than 200 basis points. Therefore, there is room for their FD rates to move up further to catch up with markets. 

No reward for longer lock-ins

Logically, deposit-taking entities ought to pay you higher interest rates if you’re willing to lock in money with them for longer tenors. This is because you take on more risk with a longer tenor and you also forego the opportunity to earn better rates should they move up. 

But longer tenure deposits are presently not offering better rates than shorter tenure ones. In the past year, much of the rise in market interest rates has been concentrated in 1 to 3-year debt instruments. These are also the time frames for which there is the biggest scramble to raise funds. This means that for FD investors, the best deals are today available in 1 to 3-year FDs. 

The table below on current FD rates on regular options, tells you that most NBFCs do not offer you a better rate because you are willing to lock in beyond 3 years. 

There are some exceptions here. HDFC is offering 7.6% for its Sapphire deposits with a 45-month tenor. Sundaram Home Finance and Shriram Finance offer 7.65% and 8.25% respectively for their 48-month FDs. (Shriram has traditionally offered higher rates owing to a riskier profile and lower credit rating of AA+ compared to AAA for other entities).

But as NBFC FD rates overall have room to move up further, we think that this is not an ideal time to lock into 4-5 year options. Investors can wait for rates to re-adjust further before considering 4–5-year lock ins.

Better deals from select banks

Ever since India revised its deposit insurance framework to insure deposits of upto Rs 5 lakh per bank per accountholder, investing in bank FDs, even if they come from smaller banks, has been a better bet for investors than NBFC FDs - which are uninsured. This article explains why: https://primeinvestor.in/an-active-strategy-for-fixed-deposits/

After this change, NBFCs ought to offer higher interest rates than banks to compensate depositors for their higher risk profile. But that hasn’t yet happened. 

Today, with banks revising their FD rates upwards much faster than NBFCs, some bank FDs offer better rates than the NBFCs on our shortlist above. You can use our bank FD tool to check out if the banks you are looking at have sound financials and enjoy high confidence ratings. 

But two bank FD programmes we like are from Equitas SFB and IndusInd Bank, as they give NBFC deposits a good run for their money. Equitas Small Finance Bank, a small finance bank with good financials, offers 7.5% on a 1-year FD, 7.75% on 2 years and 8% on 888 days (about 2.4 years).

All of these rates are more attractive than those on NBFC FDs. Senior citizens stand to earn 0.50% extra. IndusInd Bank offers 7% for 1-year FDs, 7.5% for 2 and 3 years. While NBFCs offer only 0.25% or 0.50% extra for senior citizens, IndusInd offers 0.75% extra 2 and 3-year FDs. Both these banks rank quite high on our bank FD tool. 

Tax efficiency 

Finally, if you are looking at FDs not for regular income but for growth and compounding, there are more tax-efficient options available.

Today, we have a range of target maturity debt funds that invest only in Central or State government securities, and match the bonds they own to the fund’s 4 or 5 year maturity date in 2027 or 2028. This article has the rationale and list of such funds. These funds, which carry current yields of over 7.3%, are available at expense ratios of 0.10-0.20 %.

When you choose the growth options on these funds, the interest is accumulated for pay out on maturity. At maturity, if you have held the fund for 3 years plus, the returns are taxed at the long term capital gains rate of 20% but after applying indexation benefits to your buy price. This tax treatment results in your post tax returns on such funds turning out better than FDs. 

But if you are wary of the market linked returns from MFs and prefer FDs, do keep track of our curated list of Prime Deposits so you know where the best deals are at any given point in time.