Here's an ideal mix of bank and high-interest NBFC deposits for your debt portfolio

Banks offering 7 percent or more should be sufficient as the primary place for FDs.

Depositors are spoilt for choice these days. Not only have the Reserve Bank of India’s interest rate hikes made bank fixed deposits attractive again (most bank FD rates hover at about 7 percent), but even non-banking finance companies are offering as much as 8-9 percent on deposits.

Naturally, depositors are tempted by the higher rates. But is that the right approach? Is it prudent to place your funds with whoever offers the highest rate? The answer is: No. We will discuss the reasons in a bit.

Choosing between a bank and an NBFC can be difficult when you look at factors other than interest rates. First, let’s understand something fundamental.

Why do NBFCs offer higher interest rates?

Banks and NBFCs need money to lend. And both are allowed to raise money from depositors. But NBFCs, unlike banks, don’t have the luxury of raising ‘easier and cheaper’ money via savings/current accounts (CASA).

Also, given the structure of their business and their different regulatory requirements, NBFCs have additional credit risk built into their fabric. And because of this, NBFCs generally offer higher rates than bank FDs.

While the risks are higher for NBFCs – that’s the fundamental reason they offer higher rates – this doesn’t mean that all NBFCs are highly risky. There are hundreds of NBFCs but very few are allowed to collect deposits.

All NBFCs are not the same and hence, they should be evaluated accordingly. An NBFC that lends to riskier small enterprises is definitely riskier than one that lends to housing finance, isn’t it?

An easy way to assess risk is to look at credit ratings. These ratings can help individuals determine the creditworthiness of NBFCs. Those with low ratings are riskier than those with higher ratings and generally offer higher rates.

While high rates can be very attractive, one must not forget that risky entities offer such rates to compensate for high risk-taking.

Another way is to scrutinise the finances of the company – look into the balance sheet, profit & loss statement, and non-performing asset levels. But this isn’t possible for everyone.

Also read | Fixed deposit: Top 10 banks where investors prefer to park their money

Should you invest in FDs offered by NBFCs?

Yes, you can, provided you are careful and not blinded by high rates.

Here’s how to allocate your FD money:

• If you have only a few lakh rupees to park in FDs, then earning 1-2 percent more may not result in substantial incremental benefits. Banks offering 7 percent or more should be sufficient as the primary place for FDs. Also, for those who keep less than Rs 5 lakh in the bank, the mandated insurance cover of Rs 5 lakh comes in handy.
• Money earmarked as an emergency fund should be kept in bank FDs. You don’t want to be in a financial emergency with your funds stuck in an NBFC/corporate deposit of a financially strained company. Keep things simple when it comes to emergency funds. Use bank FDs for them.
• For those who keep large amounts in bank FDs and are now thinking of NBFC deposits, here is a suggested strategy:
• It is best to spread at least 70-75 percent of your FD money in banks, that too in RBI-identified systemically important banks or larger banks.
• The remaining 25-30 percent can be deposited in other banks or NBFCs that offer higher rates. While doing so, assess the creditworthiness and background of the NBFC and try to stay with the most reputed and trustworthy names with AAA or similar high ratings.
• If a small company or NBFC offers really high rates (you will find many such offerings), then that is a big red flag and best avoided.This is how you can create a mix of FDs with banks and NBFCs in your debt portfolio.Also read | Tax-saving FDs: These banks offer interest rates of up to 7.5%

If you can lock into long-term FDs close to the peak rate, then you can enjoy high interest rates for many years even if the rate cycle turns in the near future.