Some small finance banks are giving lucrative FD options. Is it advisable to opt for such FDs at 8-9% returns than a normal debt mutual fund for short- to medium-term parking of funds?
FDs opened with small finance banks offer higher capital protection and income certainty than debt mutual funds. The RBI has granted the status of scheduled bank to all the existing small finance banks. Thus, the depositors of small finance banks qualify for the quasi-sovereign guarantee cover offered through the Depositor Insurance Scheme of DICGC, an RBI subsidiary. In case of bank failures, this insurance program would cover each depositor of each scheduled bank for cumulative deposits, including fixed, current, savings and recurring deposits, of up to Rs 5 lakh. This cover makes small finance banks at par with any PSU banks or large private sector in terms of capital protection for deposits of up to Rs 5 lakh.
On the other hand, debt mutual funds are market-linked products, which make them prone to interest rate risk and credit risk in varying degrees. Rising interest rate regimes adversely impact the returns of debt funds as bond prices and interest rate regimes have an inverse relationship. The opposite would be true during falling interest regimes.
Thus, consumers can book high-yield FDs with small finance banks, especially if those FDs are offered at higher interest rates for longer tenures. This will allow them to earn higher FD yields even after the reversal of the interest rate regime. Those having a slightly higher risk appetite can start investing in debt mutual funds once the trend of falling interest rates becomes clearly evident. Debt funds, especially those having longer duration profiles, usually generate higher returns than bank FD rates offered during a falling interest rate regime.
As published in Economic Times on August 28, 2023