The Hindu Business Line : The evergreen investment option

Stock market scams, finance/chit companies going bankrupt and dragging down savings of a life-time ... . Given all these perils, bank deposits spell stability and are still favoured despite falling interest rates.

Bank deposits have for long been considered the safest investment. Nothing that has happened in the past few years has changed that perception. Not the fall in interest rates. Not the rise in inflation. Not the scams that take place every now and then. Not even the collapse of a few banks (admittedly small ones in the cooperative sector and a few in the private sector). Public confidence in bank deposits may have been stirred but has remained unshaken. Bank deposits at the last count in early December were a whopping Rs 14 lakh crores.

There is a gilt edge to the bank deposit - especially the ones that are in the public sector, because of the implicit sovereign guarantee. Government ownership, even on a more reduced scale than before, has conferred an aura of well being and comfort to bank depositors. If something goes wrong, the government will step in, goes the refrain of the lay bank depositor. This was best exemplified by the growth of deposits in the beleaguered Indian Bank, which till recently was deep in the red.

Of course, there is the added comfort of a deposit insurance up to Rs. 1 lakh in the case of bank deposits - so even if a bank fails, you could still get at least a lakh of your deposit back. This might well be the clincher for this form of investment - although it remains a moot point whether this factor is widely known among depositors. Just the ability to get the capital back, forget the return, has transformed the ordinary, dull bank deposit into a powerful investment option.

This speaks volumes for the havoc wrought by other mediums - stock markets, mutual funds, finance companies and chit funds, among others. As scams unfolded in the equity market, leaving the retail investors in the dumps and scores of finance/chit companies failed, wiping out investors' savings, the appeal of a stable bank deposit, staid alright but safe nevertheless, only acquired a brighter hue.

Over the past three years, money has poured into bank coffers. It is perhaps debatable whether this can be seen as vote of confidence for them as an investment avenue. But whether you put it down to investor inertia or deliberate choice, bank deposits have been a significant parking lot for investment corpus. And this has been done even though interest rates on deposits have fallen by nearly four to five percentage points in recent years.

What is more, the traditional upward sloping yield curve (higher rates for longer terms) has now flattened. You get a rate close to 5 per cent whether you deposit your money for 20 days or 20 years. Yet the flow of deposits has continued unabated. It would appear that the interest rate has little to do with the volume of deposits. This is a phenomenon that debunks the traditional fear of bankers - that a reduction in rates would see a wholesale migration of deposits from their branches. That clearly hasn't happened.

U.R. Rao, Managing Director, Guardian Risk Advisors, a wealth management and portfolio advisory firm, attributes the growth of bank deposits to the lack of understanding of the alternatives and non-availability of time to monitor portfolios. "The notion that bank deposits still protect capital is strongly embedded and the a lack of understanding of the real rate of return (interest rate minus inflation rate) is another factor. For instance, a six-month deposit after tax will yield around 3.35 per cent (putting the deposit rate at 5 per cent and tax at 33 per cent) and with the inflation rate at 5 per cent, the real rate of return is a negative 1.65 per cent. So the purchasing power of the investor is declining and capital is eroding," he says.

He points out that investors in bank deposits seek a high degree of capital protection and are not concerned with the return. But with rising inflation, the original need for capital protection is defeated. This explains why alternatives such as RBI bonds, Post office schemes and PPF have become popular, he says.

So what's the bankers' take on this phenomenon?

Says Uday Kotak, Executive Vice Chairman and Managing Director, Kotak Mahindra Bank, "It bothers me that returns on bank deposits for investors are going down. The investors have got burnt in many other investment products and are shy to come back. But because returns are poor, they need to look for other avenues. We are seeing two conflicting mindsets. But the nation is in transformation mode today. From being a nation of savers we are moving to be a nation of investors."

So what should an investor do?

Says Rao, "A bank deposit in the current scenario is not an ideal investment tool, except for liquidity. It would be preferable to invest in a floating rate fund where an investor can ride the yield curve (benefit from increase in rates) and also get tax free returns."

He adds, " Our recommendation is to use the bank deposit purely as an emergency fund (say for medical expenses) since with the ATM facility today, cash is available literally 24/7. Other expenses can always be dealt with more time at one's disposal and with alternatives being available such as mutual fund encashment s. Bearing in mind an individual's health, lifestyle and size of portfolio, we would recommend that for a 30-40 year old, between 2 and 5 per cent of their investments could be in bank deposits and for 50-60 year olds, about 5-10 per cent of their portfolio could be in bank deposits.

P.N. Venkatachalam, Managing Director, State Bank of India, the largest bank in the country, feels that interest rates in the economy have come close to the bottom and there is now little room for further reductions. He feels further reductions could happen in post office deposits scheme, PPF, NSC, and the like, since they have to be aligned with market rates.

If and when that happens, it is only likely to enhance the appeal of bank deposits. After all, there won't be many who want to lock up money in such schemes for 6 or 15 years. And investors in these schemes will have to live without the prospect of an early or flexible withdrawal as well as the possibility of tax concessions being scaled down or withdrawn. He doesn't think the investor will put up with these disadvantages, and all for a marginal premium over a bank deposit rate, and will continue to plump for bank deposits.

Illustration by Ravikanth Nandula

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