Bank FDs vs. NBFC FDs: Comparing Risks and Returns

Bank Fixed Deposits (FDs) and Non-Banking Financial Company (NBFC) Fixed Deposits are popular investment choices for people seeking secure returns. Both options offer a relatively stable income, but they have some differences in terms of risk and return. In this article, we will explore and compare these two types of fixed deposits, with a focus on helping you make an informed choice based on your needs.

What is a Bank Fixed Deposit?

A Bank FD is a traditional deposit option offered by banks. When you open an FD with a bank, you deposit a certain amount for a fixed tenure, and the bank provides you with a set interest rate. Banks are regulated by the Reserve Bank of India (RBI), making these deposits safe and stable.

Key Features of Bank FDs

• Fixed Tenure and Rate: Banks offer fixed rates for specific tenures, typically between 1 to 10 years
• Low Risk: Bank FDs can be considered safe as banks are regulated by the RBI and comply with its guidelines
• Insurance Cover: Bank deposits are insured up to ₹5 Lakhs per depositor per bank by the Deposit Insurance and Credit Guarantee Corporation (DICGC)

What is an NBFC Fixed Deposit?

An NBFC Fixed Deposit is similar to a bank FD but is offered by Non-Banking Financial Companies. NBFCs provide loans, financing, and other financial services, but they do not offer savings accounts. The RBI regulates larger NBFCs, but they are not as closely monitored as banks.

Key Features of NBFC FDs

• Higher Returns: NBFCs may offer higher interest rates than banks
• Flexible Tenures: NBFCs may have flexible tenures for FDs, ranging from a few months to several years
• Increased Risk: Unlike bank FDs, NBFC deposits do not carry insurance coverage, which could expose investors to a higher risk

Comparing Risks: Bank FDs vs NBFC FDs

Safety of Principal :

Bank FDs are considered one of the safest investment choices. They are highly regulated and offer insurance coverage through the DICGC, ensuring a degree of protection for deposits up to ₹5 Lakhs.

NBFC Fixed Deposits, while regulated by the RBI, do not come with insurance coverage. Although reputable NBFCs with high credit ratings may be safer, they carry a higher risk compared to bank FDs.

Default Risk :

Banks, especially public sector banks, are seen as stable institutions with a low chance of default. Even if a bank faces financial trouble, the DICGC insurance scheme protects depositors to some extent.

NBFCs are more vulnerable to default risk, and investors should consider the credit rating of an NBFC FD before investing. Ratings from agencies like CRISIL, ICRA, and CARE provide insight into the stability of an NBFC. Look for high-rated NBFCs, such as those with AAA or AA+ ratings, to minimise risk.

Returns Comparison

The main reason many investors consider NBFC FDs is the potential for higher returns. While bank FDs typically offer interest rates ranging from 3% to 6%, NBFC FDs may offer rates as high as 8% or more, depending on the tenure and market conditions.

Interest Rates :

Banks adjust their FD rates based on RBI policies, economic factors, and liquidity needs. Typically, bank FDs offer moderate returns but with a high level of security.

NBFCs, on the other hand, often provide higher rates to attract investors. This could be appealing for those who prioritise returns over security. However, higher returns may mean taking on higher risk, as NBFCs use FD funds to lend in markets that could carry more risk.

Liquidity and Premature Withdrawals

Bank FDs allow for premature withdrawal with a penalty. The terms vary by bank, but most banks charge a small fee or reduce the interest rate if you withdraw before the FD matures.

NBFCs also allow premature withdrawal, but the penalty charges may be higher. Additionally, some NBFCs may have more restrictions or longer waiting periods for premature withdrawal. It is essential to review the terms before choosing an NBFC FD if liquidity is a priority for you.

Tax Implications

Both bank and NBFC FDs have similar tax treatment. The interest earned on FDs is taxable under your income tax slab rate. Banks and NBFCs deduct Tax Deducted at Source (TDS) on interest if it exceeds ₹40,000 (or ₹50,000 for senior citizens) in a financial year.

Evaluating Tenure Options

Bank FDs generally offer fixed tenure options ranging from a few months to up to 10 years. This provides investors with more choices based on their financial goals.

NBFCs also offer a range of tenure options but often allow shorter tenures. This can be beneficial for investors who may need access to funds in the near term or prefer shorter investment horizons. However, as mentioned earlier, the tenure flexibility in NBFC FDs may come with restrictions on early withdrawal.

Suitability for Different Investors

Bank FDs :

Bank FDs are a preferred choice for conservative investors who prioritise safety over high returns. They are suitable for risk-averse investors, especially those looking to protect their principal amount while earning modest returns. Bank FDs are also a good option for senior citizens, as many banks offer slightly higher interest rates to senior depositors.

NBFC FDs

NBFC FDs may appeal to investors seeking higher returns and are willing to accept higher risk. If you choose to invest in an NBFC FD, consider the NBFC’s credit rating and its track record. Investing in NBFC FDs is generally more suitable for those with a moderate-to-high risk tolerance.

Note: The interest rates provided are indicative and may vary according to eligibility, lending terms, and lender discretion. For the latest information, please visit the official website of the lending bank or NBFC.

Making the Choice

Both bank FDs and NBFC FDs have their pros and cons. Here’s a quick recap to help you decide:

• Choose Bank FDs if you value safety, prefer government insurance coverage, and do not mind lower returns.
• Choose NBFC FDs if you seek higher returns, have a moderate risk tolerance, and are comfortable with unsecured deposits.

It is also possible to diversify by investing in both bank and NBFC Fixed Deposits. This approach allows you to enjoy the security of a bank FD while capturing the higher returns of an NBFC FD. Diversification could spread your risk across different financial institutions and give you flexibility in terms of liquidity.

Also Read: NBFC vs Bank: How to Choose the Best

Conclusion

Bank FDs and NBFC FDs both serve as reliable investment options, each with unique benefits. While bank FDs are safer, NBFC FDs could offer higher returns for investors willing to take on more risk. Always review the terms and conditions, check the credit ratings, and ensure the investment aligns with your financial goals and risk tolerance.