Banks And NBFCs: Weighing The Costs And Benefits Available To A Depositor

By: Tavaga Research

With several lending institutions available in the financial services space, an individual, seeking an investment avenue, is faced with a plethora of investment decisions. An individual may have to approach a bank to avail of the low-risk products, such as term deposits. Which banking institution should an individual approach? What will be the security of the said deposits with different banks? What rate of return can be expected?

Scheduled Commercial Bank

Scheduled commercial banks are financial institutions that accept deposits, make loans, and offer other banking services. A scheduled commercial bank is included in the second schedule of RBI Act, 1934. There are four types of scheduled commercial banks in India: Public sector banks, private sector banks, foreign banks, and regional rural banks. Some of the popular commercial banks are SBI, HDFC, HSBC, and Kotak Mahindra Bank. The commercial banks are regulated by the RBI under the framework of the RBI Act 1934 and the Banking Regulation Act 1949

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Co-operative Banks

Co-operative banks are financial entities that belong to their members and are run on a co-operative basis, providing traditional banking services. This essentially means that the members of the bank are both customers and the owners at the same time. These banks are registered under the States’ Cooperative Societies Act and are regulated by the Reserve Bank of India (RBI). The Banking Regulation Act 1949 and the Banking Law (Co-operative Societies) Act 1955 govern the co-operative banks. Cooperative banks can be classified into Urban and Rural banks based on their region of operation.

Difference between Commercial Banks and Cooperative Banks

Commercial Bank	Cooperative Bank
Incorporated under the Banking Regulation Act, 1949	Incorporated under the Cooperative Societies Act, 1965
Larger area of operation compared to cooperative bank	Smaller area of operation
The borrowers and depositors in commercial banks are account holders and do not have any voting power.	Borrowers and depositors are members that have voting rights in decisions of the cooperative bank.

Non-Banking Financial Companies (NBFCs)

NBFC’s are financial institutions engaged in financial services like retirement planning, loan, and advances, credit facility, insurance, etc. These institutions have played an integral part in developing the financial sector. They are also referred to as shadow banks.

NBFCs may be categorized as infrastructure finance companies, micro-finance institutions, housing finance companies, investment companies, asset finance companies, and more of the like.

Under the RBI Act 1934, the Reserve Bank of India has been given the powers to register, issue directions, lay down the policy, regulate, inspect, supervise, and exercise surveillance on NBFCs.

Small Finance Banks

Small finance banks are financial institutions that provide basic banking services of accepting deposits and lending to unserved and underserved sections of society.

• Small Finance Banks are regulated by RBI and also covered the deposit insurance scheme by Deposit Insurance and Credit Guarantee Corporation
• Minimum paid-up capital would be 100 Crores
• Promoters must contribute a minimum of 40% equity capital and should be brought down to 30% in 10 years

Difference between a commercial bank and a small finance bank

	Commercial Banks	Small Finance Banks
Minimum Paid Up Capital	500 Crores	100 Crores
Promoter Share in equity capital	51%	40%

How safe are the deposits with banks and NBFCs?

The string of defaults and frauds in the NBFC and the banking space have shaken people’s trust in the ability of these institutes to be catalysts in the process of economic transformation. Ranging from IL&FS defaulting on its repayments, a mini-run on Yes bank to the recent Punjab and Maharashtra Cooperative (PMC) Bank fiasco, the frauds in the financial services sector have pushed the public to their backfoot. The pandemic only exacerbates those fears.

To restore that trust, the government has responded by raising insurance coverage on deposits in banks from Rs 1,00,000 to Rs 5,00,000. The Deposit Insurance and Credit Guarantee Scheme (DICGC) insures each deposit of up to Rs 5,00,000 if the bank goes into liquidation. Scheduled commercial banks and small finance banks are covered under DICGC insurance. However, the depositors should know that NBFC deposits are NOT covered under the scheme.

Although NBFC’s offer higher rates on fixed deposits, compared to bank fixed deposits, people have to be mindful of the corresponding higher risks associated with those investments. The difference in the risk emanates from the fact that bank deposits are protected by insurance as mentioned above, and it is unlikely that the government or the RBI would let a banking institution fail because it is not in their best interest. Also, banks operate in tighter regulations compared to NBFC’s, providing an additional layer of protection to the depositors.

Similar to commercial banks, cooperative banks are protected by deposit insurance up to Rs 5,00,000. Risks for cooperative banks emanates from their dual regulation problem, which essentially means that they are regulated not just by the RBI but also by their respective registrars (central and various cooperative societies). Dual regulations allow loopholes in the system, allowing those banks to hide their irregularities under the carpet. Many cooperative banks have been liquidated in the past. In 2012-13 alone 13 cooperative banks went bust, indicating the risks involved with cooperative bank deposits.

Comparison of Fixed Deposit rates across lending institutions

Best NBFCs for Fixed Deposits

NBFCs	Regular depositors	Senior Citizen	Tenure
Bajaj Finance	7.10%	7.35%	12 – 60 months
Mahindra Finance	6.45%	6.70%	12 – 60 months
Shriram Transport Finance	8.40%	8.80%	12 – 60 months
Kerala Transport Development Finance Corporation	8.00%	8.25%	12 – 60 months

Source: Company Website, Tavaga Research

Bajaj Finance Fixed Deposit

• Systematic Deposit Plan is the key feature in that the depositor has the option to invest in the FD every month. Each deposit is treated as a separate FD with a minimum tenure of 12 months to a maximum tenure of 60 months.

• Only Indian NBFC to achieve an international rating by S&P Global of ‘BBB’

• Lock-in period of 3 months

• 75 percent of the FD can be taken out as an online loan against the deposit after the initial lock-in period

Mahindra Finance Fixed Deposit

• Mahindra Finance Fixed Deposits offer a high level of safety, with the CRISIL rating of ‘FAAA’

• The minimum amount of deposit: Rs 5,000

Shriram Transport Finance Fixed Deposit

• Accredited with a rating of ‘FAAA’ by CRISIL (highest level of safety)

• The minimum amount of deposit: Rs 5,000

All the fixed deposits offered by NBFCs offer an option for cumulative and non-cumulative option. The cumulative option enables a depositor to collect interest at maturity, which allows for compounding of interest. The non-cumulative option lets the depositor opt for monthly, quarterly, or semi-annually pay-outs.

Best Small Finance Banks for Fixed Deposits

Small Finance Bank	Regular depositors	Senior citizen	Tenure
Suryodaya Small Finance Bank	7.50%	8.00%	60 months
Jana Small Finance Bank	7.50%	8.00%	24 – 36 months
North East Small Finance Bank	7.50%	8.00%	730 – 1095 days
Equitas Small Finance Bank	7.35%	7.95%	888 days
Utkarsh Small Finance Bank	7.00%	7.50%	700 days

Source: Company Website, Tavaga Research

Small Finance Banks also allow the cumulative and non-cumulative options for interest due. Some banks offer a mobile-based application to operate the account with digital banking benefits.

The minimum amount of deposits with Small Finance Banks may be as low as Rs 1,000.

Premature withdrawal of deposit attracts a penalty in the form of interest reduction from the original contract rate.

Best Co-operative Banks for Fixed Deposits

Co-operative Bank	Regular depositors	Senior citizen	Tenure
Repco Bank	6.75%	7.25%	12 – 24 months
Andhra Pradesh State Co-operative Bank	6.50%	7.10%	12 months
Bharat Co-operative Bank	6.35%	6.85%	60 months
Janata Sahakari Bank	6.25%	6.50%	12 – 36 months
Saraswat Bank	5.85%	6.35%	60 months

Source: Company Website, Tavaga Research

Co-operative banks offer a higher rate of interest over a short period as compared to other banks. Moreover, it is easier to apply for a fixed deposit scheme with co-operative banks due to lower standards for eligibility.

The minimum investment amount may be as low as Rs 1,000 for most co-operative banks. The maximum tenure for most banks is generally 10 years.

Best Scheduled Commercial Banks for Fixed Deposits

Commercial Bank	Regular depositors	Senior Citizen	Tenure
HDFC Bank	5.10%	5.60%	36 months
RBL Bank	7.15%	7.65%	36 months
Kotak Bank	4.90%	5.40%	36 months
IndusInd Bank	6.75%	7.25%	36 months
SBI	5.30%	5.80%	36 months

Source: Company Website, Tavaga Research

How to choose the right deposit scheme?

Financial goals of the depositor guide the decision of the best suited fixed deposit scheme. The factors affecting the selection of a deposit scheme may be as follows:

• Rates of Interest: Different lending institutions offer different rates of interest across several maturities. Therefore, the financial goals of the depositor can direct the required return on the deposits.
• Tenure of the deposit: Tenure reflects the interest rate environment prevalent in the economy. While short-term rates are predictable to a certain degree, rates on long-term deposits can bring about a significant change in the deposited amount. Furthermore, tenure also depends upon the liquidity need of the deposit. Premature withdrawals of FD generally attract a penalty in the interest rates.
• Pay-outs: Cumulative and non-cumulative options on fixed deposit schemes affect the effective annual yield of the deposit. It also enables the depositor to align the pay-outs with their liquidity needs.  For example, a senior citizen may opt for monthly pay-outs to fulfill the utility bills, such as those of electricity, phone, and gas connections.
• Safety of deposits: Fixed deposits are not free of risk, as the banks are also prone to failure. Therefore, it is always recommended to check the rating of the lending institution and ensure that the risk is in line with the return required.

Tax consideration for Fixed Deposits

Fixed deposits are fully taxable as the yield on the deposits increases the income of the depositor. Fixed deposits, in the income tax filings, are taxed under the head of ‘income from other sources’. The return on fixed deposits is taxed as per the applicable tax slab rate of the depositor.

However, senior citizens are eligible to avail of a flat tax deduction of Rs 50,000 annually on the interest income arising from fixed deposits (also applicable to savings account and recurring deposits).

Tax Deducted at Source (TDS) is an important factor while assessing the tax liability arising out of fixed deposits. Tax on fixed deposits is paid partly by the depositor and partly by the interest payer. Therefore, the depositor must remember to claim a refund or adjust the TDS with their total tax liability if the TDS deducted is more than the depositor’s total tax liability.

• TDS event arises when the return on FD exceeds Rs 40,000 (Rs 50,000 for senior citizens) annually.
• On providing the bank with a PAN card, the depositor’s TDS deducted will be limited to 10 percent. However, in the absence of a depositor’s PAN card, TDS deducted on the FD returns will be 20 percent.
• There may arise a situation where the interest income is more than Rs 40,000 in a year but the total income is less than the minimum taxable income. Therefore, the bank is not allowed to deduct TDS if there is no tax liability for the depositor. Forms 15G (for regular clients) and 15H (for senior citizens) may be submitted by the depositors at the beginning of the year to claim a TDS exemption.

Tax-saving FDs offer tax deduction up to Rs 1,50,000 under the Section 80C. Such deposit schemes may offer lower than competitive rates and have a minimum lock-in period of 5 years with no premature withdrawal facility.

Fixed Deposits made at a post office in India are free from TDS deductions.

Alternate deposit/investment options for individuals

Apart from fixed deposits, the individuals have more options commensurate with higher risk. Should the individual have a slightly higher appetite for risk, the following options may be considered:

1. Corporate Fixed Deposits: Similar to term deposits in banks, companies also offer fixed deposit schemes for a fixed term at a fixed interest rate. Company FDs are generally offered by NBFCs. However, credibility is a key factor when choosing an FD scheme with corporations. The credit rating of the company offering the fixed deposit scheme is of utmost significance. Because the risk may be higher for a risk-averse investor in corporate FDs, the depositor must be certain of the return offered.
2. Passive Investments: To gain more exposure to capital markets, especially the stock market, exchange-traded funds (ETFs) are one of the best investment vehicles. ETFs typically track the benchmark or the index, with minimum deviations from the market portfolio. ETFs also offer liquidity as they trade on the stock exchange.
   1. Liquid Mutual Funds and ETFs: Liquid funds constitute liquid debt investments, which are money market instruments investing in short-term securities. Typically, short-term securities are generally Government Treasury Bills and other highly rated fixed-income investments. Liquid funds offer a stable return with sufficient liquidity.
   1. Index Funds: Pooled investment funds that are mandated to invest in an index, such as Nifty IT, index funds mimic the performance of the index. Index funds enable an individual to gain sector exposures.