Should you invest in fixed deposits of small finance banks promising over 9% returns?

Since May 2022, the Reserve Bank of India (RBI) has raised the repo rate by 250 basis points (bps), making fixed deposits once again a desirable investment for investors in fixed income. Investors can receive returns on their investments of more than 9% while still receiving DICGC coverage since fixed deposit interest rates are on the rise. Yes, you heard it right, a select few small finance banks (SFBs) are giving their customers returns on fixed deposits (FDs) of over 9%, which is not only significantly higher than those offered by public and private sector banks but also by small savings schemes.

Best FD Rates

Ittira Davis, MD & CEO, Ujjivan Small Finance Bank

Fixed Deposits (FDs) are a great investment for our consumers, especially with rising rates. FDs offer a safe, consistent investment with guaranteed returns. They are low-risk and perfect for risk-averse investors. Customers can conveniently invest their money for a specified time and earn returns using FDs.  FDs also offer better interest rates than savings accounts and other low-risk investments. Customers seeking a regular income can benefit from FDs.

Anita Gandhi, Whole Time Director, Head of Institutional Business, Arihant Capital Markets Ltd

As per RBI, small finance banks have been set up to undertake basic banking services to unserved & underserved sections including small business units, farmers & others. The interest rates they charge is much higher than the interest charged by commercial banks. Their Net interest Margins are also high & therefore they can offer higher interest rates. They mobilise money for lower section of the economy. RBI has given 5 lacs insurance on Deposits kept with banks in eventuality of any bank collapse. Therefore, one can safely invest deposits up to 5 lacs in such banks. However, for any investment above 5 lacs, investor need to monitor functioning of the bank on the basis of Quarterly results.

Somya Srivastava, CEO of Prayatana Microfinance

1. Should you invest?

For individuals looking for better yields than regular banks, investing in tiny finance institutions with over 9% return on FDs may be a suitable choice. Before making an investment, it's crucial to evaluate the bank's reputation and performance. Before making any investment selections, investors should also consider their financial objectives and risk tolerance.

2. What are the risks involved?

The chance of payment default, issues with liquidity, and prospective fluctuations in interest rates are among the dangers connected to investing in small finance banks. Before making an investment, you should do your homework and assess the bank's financial standing and track record.

3. What should be my investment strategy?

The portfolio should be diversified among various asset classes and the FD's tenure would be considered in a wise investment strategy. Also, what must be considered by investors is the fact that more significant returns typically entail more risk.

4. Should I lock in my FD in a small finance bank for 80c deductions?

For tax reasons, it would be advantageous to lock in an FD in a small finance bank for 80C deductions. The lock-in period must be considered, though, as early withdrawals could incur fees. Before making a choice, investors should weigh the prospective profits against other investment options.

CA Manish Mishra, Virtual CFO

SFBs were established with an emphasis on microfinance and small business loans to offer financial services to underbanked and unbanked segments of society. They provide deposit products such savings accounts, current accounts, and fixed deposits and are subject to RBI regulation.

Despite the riskier nature of investing in SFBs' FDs, the higher interest rates could seem alluring. The financial stability of SFBs may not be as well-established as that of larger banks because they are relatively new institutions. Therefore, investing in SFBs can carry a higher risk.

The 9% interest rate being given now may not be available tomorrow because the interest rates offered by SFBs may be subject to change based on market conditions.

Since the interest on FDs is taxable, investors must think about the tax ramifications of making an investment in FDs. Additionally, unlike some other banks, SFBs might not provide tax-saving FDs.

For conservative investors searching for consistent earnings, FDs are a low-risk investment alternative. However, if an investor is seeking more returns, they might want to look into alternative investing choices, such as stocks or mutual funds.

In conclusion, some investors may find that investing in SFBs' FDs is a wise choice, but it's crucial to thoroughly weigh the advantages and disadvantages before deciding. Additionally, before making an investment, investors must conduct due diligence and examine the SFB's financial health.

Sahen Karamchandani, Founder of WealthinIndia.com (Wii Investments Private Limited) 

Before making any investment decisions, investors should be aware of the risk associated with Small Finance Bank FDs, which offer 9% returns. Credit risk is the main danger of investing in Small Finance Bank FDs. However, the DICGC, a division of the RBI that covers all bank deposits up to Rs. 5 lakh, also extends to deposits made with small financing banks. Therefore, up to Rs. 5 lakh can be invested without worrying about the principal or interest. Any investment amount above that must be looking for an alternative source of investing.

Debt mutual funds are an alternate investment choice for investors seeking higher returns. These funds make investments in government securities, bonds, and other fixed-income instruments. When compared to bank FDs, debt mutual funds give higher returns, holds more liquidity, and the returns are tax-efficient for investors in lower tax brackets. 

Juzer Gabajiwala- Director, Ventura Securities

There are 2 decisions here which are to be considered. First whether one should opt for section 80C and then the second one being whether to go for a Small Finance Bank(SFB). For the first decision, you should opt for section 80C only if the old tax regime is beneficial to you, then only you should opt for a tax saving FD. If you are opting for the new tax regime then the section 80C fixed deposit will have no benefit. Also remember that the limit for section 80C will be restricted to 1.50 lacs. 

The second decision is based on the high interest provided by the SFB. One can consider this as an investment but should ensure that the amount (principal and interest) does not exceed 5 lacs. There is guarantee provided by RBI through DICGC upto Rs. 5 lacs. Also you should go to their website and check that the bank is listed to be eligible for the insurance cover. So both the decisions are independent and should not be linked to each other.

Edul Patel, CEO and Co-Founder of Mudrex

There are some Small finance banks offering interest rates above 9% on fixed deposits (FDs), which may attract investors. However, compared to larger banks, small finance banks may have a higher risk of default due to the higher cost and limited capabilities of raising capital. It's essential to research their financial stability and your goals before investing. FDs offer guaranteed returns but limited liquidity. So, assessing risks, evaluating goals, and conducting thorough research before investing is vital.

Nehal Gupta, Director, AMU Leasing

Investing in a fixed deposit (FD) with a small finance bank offering over 9% return can seem like an attractive option for those looking to earn a higher interest rate than traditional banks. However, it's important to keep in mind that higher returns usually come with higher risks. Small finance banks operate with a smaller capital base, and their focus on unsecured lending to riskier segments of the population makes them more susceptible to defaults and non-performing assets.

Before investing, it's crucial to do thorough research on the bank's financial stability and reputation. Investors should also diversify their portfolios by spreading their investments across different financial instruments and banks. Locking in an FD for 80C deductions is a good tax-saving strategy, but it's crucial to weigh the benefits against the potential risks.

Ultimately, the decision to invest in a small finance bank FD should be based on individual financial goals and risk appetite. It's advisable to consult with a financial advisor to determine the best investment strategy based on your unique circumstances.