Published On: Sun, Aug 21st, 2016

How NBFCs Offer Higher Interest Rates on FDs than Banks?

A Non-Banking Financial Company (NBFC) is a category of  financial institutions that provide some types of banking services, but do not hold a banking licence. Their ambit includes hire purchase, leasing, asset finance, loan companies, and residuary non-banking companies. Over 50% of a non-banking finance company’s income is derived from its financial assets.

NBFCs offer a variety of banking services. Credit facilities and loans, retirement planning, private education funding, underwriting shares and stocks, and trading in money markets are just a few services that are offered. The number of NBFCs has increased greatly over the past years due to industrial, retail, and venture capital companies entering the lending business.

All banks that are governed by the RBI are authorised to accept Fixed Deposits from the public. However, not all NBFCs are permitted to accept Fixed Deposits from the public.

Pre-requisites for an NBFC to accept Fixed Deposits from the public are many. To begin with, it must be registered with the Reserve Bank of India, and must have specific authorisation which will enable it to accept deposits. The authorisation certificate must also be displayed for the benefit of any depositors. Additionally, the bank must have a minimum investment grade rating by an approved credit rating agency.

And that’s not it. FD interest rates cannot be higher than the rate approved by the RBI. In addition, Fixed Deposits offered should also not be for a tenure of less than 12 months and more than 5 years. Thus, the maximum tenure that can be offered by NBFCs is 5 years.

Just as FD interest varies between banks, the interest offered by NBFCs on Fixed Deposits also varies. However, the upper limit cannot exceed the RBI approved rate. In such a case, an FD interest rate calculator can be handy to estimate the predicted maturity amount.

There are many reasons as to why NBFCs offer a higher interest on their Fixed Deposits.

Higher Risk

In the equity market, returns are proportionate to the risk taken. The higher the risk exposure, the greater your return. Fixed Deposits with NBFCs are unsecured, and in the event of default in the repayment of FDs, there is an inherent risk, as deposits held with NBFCs have no guarantee (unlike bank deposits, which are covered by Deposit Insurance and Credit Guarantee Corporation to the extent of Rs. 1 lakh per bank).

The return for the risk taken is compensated in the form of higher interest.

No CRR or SLR

Though NBFCs have to follow RBI guidelines, unlike banks, they are not required to maintain CRR (Cash Reserve Ratio) or SLR (Statutory Liquidity Ratio) with the Reserve Bank of India. Banks adjust their deposit rates based on the CRR. If the RBI mandates a high CRR, then banks have lesser funds at their disposal. This necessitates them to accept deposits from public by offering higher rates of interest. If the CRR is low, then you earn a comparatively lower interest. This is the common reason by RBI rate cuts impact FD interest Rates.

Since NBFCs do not carry a banking licence, they are not required to maintain CRR or SLR. As a result, they are able to offer a higher return on FDs.

Investment in Financial Assets

An NBFC earns its income by deploying its financial assets. In fact, a company is classified as an NBFC if it earns more than 50% if its income from financial assets.  A good return on its financial assets helps the NBFC to offer a higher interest rate to its depositors.

High Lending Rates

When you avail a loan from an NBFC, the interest rate on the loan is usually higher than the interest charged on bank loans. When they are charging a higher rate on loans, they’re able to offer higher interest rates on deposits as well.

As an investor, your aim is to maximise your return. This objective is met by investing in Fixed Deposits with NBFCs.

However, a word of caution:

Deposits with NBFCs are unsecured. Hence, it’s best to invest in NBFCs that carry a credit grade that’s at least an AA+. A prudent investor must do his background research and gather adequate information of the credentials, financial history, and credit rating of the NBFC before making his FD investment.