Bank FDs sahi hai: Why fixed deposits may be better than debt mutual funds

The returns may be similar, but there is nothing better than bank FDs when it comes to safety - the principal is safe, at least in scheduled commercial banks, given how Indian banks are regulated

Union Finance Minister (FM) Nirmala Sitharaman last week asked public-sector banks to make concerted efforts to mobilise deposits through special drives. This is because deposits have been lagging behind loan growth. By July-end deposits grew 10.6 per cent year-on-year compared to 13.7 per cent growth in loans. Worse, according to the Reserve Bank of India (RBI), the low-cost current and savings accounts (CASA) of banks had declined from 43 per cent of the total deposits a year ago to 39 per cent this financial year. About 10 days before the FM met the bankers, she had pointed out lenders needed to focus on raising smaller deposits that came in “trickles” but were the “bread and butter” of the banking system. Again the concern was the widening gap between deposits and credit.

Why are bank deposits not increasing in an economy with a 7-8 per cent growth rate in gross domestic product, double-digit revenue collection from taxes, and massive capital expenditure by the government? The most popular theory is that savers are taking their money out of banks and investing it elsewhere. Apparently, this is especially common among the young, who prefer riskier assets like mutual funds and equities. Nearly 47 per cent of term deposits are now held by senior citizens. RBI Governor Shaktikanta Das has voiced the same concern, pointing out how alternative investment avenues have become more attractive to retail customers. “Banks are taking greater recourse to short-term non-retail deposits and other instruments of liability to meet the incremental credit demand,” he said, and that might expose the banking system to liquidity issues. Some reports indicate the share of bank deposits in gross financial savings of households has fallen to 29.4 per cent from its long-term average of 33 per cent, whereas the share of mutual funds has risen from 2 per cent to 6 per cent. Some others think this is fallacious. Banks sit at the centre of all financial transactions. If money leaves the banking system and goes into mutual funds, it also comes back into the bank accounts of those whose shares are purchased by mutual funds.
 

The solution
 

Assuming that there are strong reasons for the government to be concerned about lower deposit growth, what could be done about it? Goading bankers usually fetches a poor outcome. Previous finance ministers, even forceful ones like P Chidambaram, have failed to encourage public-sector bankers to lend more or persuade people to keep more money in bank deposits. Public-sector banks have their own compulsions. Fortunately, there is a simpler way to grow bank deposits: It is to encourage a shift from debt funds to bank deposits. This shift is easy because, over the past few years, the government’s tax policies have made debt funds far less attractive than bank deposits. The outcome of this initiative will be significant. More than Rs 15.44 trillion is now invested in debt mutual funds. Of this, 30-40 per cent could come into bank deposits with the appropriate nudge. What can be done to make this happen? Three things: Incentives for savers (tweak fixed deposits from a tax angle); a marketing campaign along the lines of bank deposits sahi hai; and removing malincentives for bankers who, doubling up as investment advisors, discourage savers from putting money into fixed deposits (FDs).
 

Feature for feature, bank FDs are indeed better than debt funds today, mainly thanks to Ms Sitharaman. Their returns are similar but when adjusted for risk, the returns are better. The interest rate and principal of FDs do not fluctuate with changing market conditions. There is nothing better than bank FDs when it comes to safety — the principal is safe, at least in scheduled commercial banks, given how Indian banks are regulated. But most importantly, until 2023, debt mutual funds had a tax advantage. The tax benefit for long-term debt mutual funds was eliminated by the government on April 1, 2023. So now, debt funds are on a par with bank FDs. This means the returns are taxed as any other income of the investor. And yet, more than Rs 15 trillion is sitting in debt funds.  
 

This money will easily shift with a creative marketing campaign, but some tax benefit will make it even better. The only major difference between FDs and debt funds is that gains from the latter are taxed on redemption, while interest income on FDs is taxed on an accrual basis. While conceptually this is valid — debt funds fetch capital gains while FDs fetch income — since these two asset classes compete with one another, there is a case for creating at least a special class of bank FDs whose interest income will be taxed only on withdrawal. Such FDs will allow a much higher compounding of income for savers and, therefore, will eventually lead to higher tax collection for the government, on redemption. 
 

There is a fly in the ointment, though. Banks are a hotbed of mis-selling third-party products, mainly traditional insurance. We have come across innumerable cases where bankers encourage savers to put money from FDs on maturity into a traditional life insurance product, rather than renew the bank FD, because selling insurance earns them a hefty commission. Even public-sector banks have high targets for selling insurance to boost their profits. So if the FM wants to see the “bread and butter” of banks grow, tackling such mis-selling will help. It is about time this was done since mis-selling insurance has continued unabated for about two decades despite protests from bank unions themselves.

The writer is editor of www.moneylife.in and a  trustee of the Moneylife Foundation; @Moneylifers