NBFCs offer higher deposit rates than banks; invest after ascertaining risk

The crisis in Infrastructure Leasing & Financial Services (IL&FS) seems to have rattled non-banking financial companies (NBFCs), and many have started raising their deposit rates. For example, NBFCs, including LIC Housing Finance, Mahindra Finance, PNB Housing Finance, Shriram Transport Finance, Bajaj Finance and some others, have increased fixed-deposit rates in October and November.  

State Bank of India (SBI), the largest bank in the country, is offering an interest rate of 6.85 per cent for a 5-10-year fixed deposit (FD). In comparison, some NBFCs such as Shriram City Union Finance are offering 8.25-8.88 per cent on their 1-5-year FDs. 
Experts say the recent rise has been a fallout of the IL&FS crisis, which hurt many mutual fund houses and their investors. Consequently, fund houses have become more conservative about investing in NBFC papers. And to attract retail customers, NBFCs have been forced to give the carrot of higher interest rates. Says Rachit Chawla, founder and chief executive officer (CEO), Finway: "The IL&FS crisis has shaken the confidence of investors. NBFCs are exploring all sorts of avenues to raise money and regain the trust of investors."

The increase in FD rates is mostly to attract investors, as well as expand the deposit base. With these interest rates, NBFCs are hoping to attract the fixed-deposit investor who invests in bank deposits. "Given that retail investors' money is stickier in nature, for the long-term, it provides stability to NBFCs' books," says an investment advisor.  

The question: Should retail investors go for such issues? Says Malhar Majumder, founder of Positive Vibes Consulting and Advisory: "Bank FDs are backed by deposit Insurance (up to Rs 100,000). On the other hand, NBFC investors are unsecured debtors. Depositors should watch out for risk (quality of balance sheet, earnings) before taking an exposure."

The rates of interest are attractive but risks, too, are there. Investment experts, therefore, suggest that there should a multi-level approach towards investing in NBFCs, especially ones offering extraordinarily high rates.

One, limit your exposure to papers of a single company to a maximum of 10 per cent of the debt portfolio. For instance, if you have Rs 1 million to be invested in FDs, you should not allocate more than Rs 100,000 to one institution. And keep the overall exposure to NBFC papers to 30 per cent. In other words, you cannot/should not invest in more than three companies that are offering high rates. Remember, the debt part of the portfolio is usually to provide stability to the overall portfolio. 

Then, look at the rating of the paper. Adds Naveen Kukreja, CEO and co-founder, Paisabazaar.com: "Investors with a moderate to high risk appetite should consider NBFC deposits as an alternative to bank FDs. However, instead of being swayed by higher interest rates, one should look at NBFCs with the credit rating of AAA, which is considered to be the safest regarding the repayment of their financial obligations." The good news is that there are multiple rating agencies providing the credit rating of the same paper. So, it is essential to go through all of them. While there is no guarantee that a top-rated company will not default, a good rating can provide a lot of comfort to the investor.  

Most importantly, don't be swayed by advertisement pitches. It pays to be conservative even in the debt market.  

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