Advice on Safety of Bank Fixed Deposits

Client’s question: My sister, ABC who has been staying in US for the last twenty years is planning to quit US and return back to India sometime early next year. She would like to get advice on where to invest her retirement corpus so that there is minimal risk and at the same time she can get a reasonable return.

Does your company have any website that gives details of the services that you provide which she can go through?

Mr. Gerard Colaco: You have been referred to us by your brother Mr. XYZ. Our firm has no website. This is deliberate. The main reason for this is that investment advisory services and financial planning are specific to an individual and general content on a website can be dangerous, especially if inapplicable to an individual case. Furthermore, we are not looking for new business from unknown sources.

While we can very easily advise you on financial and tax planning and personal investment, including investment for retirement, we prefer to deal with individuals who do not leave everything to us and take some trouble to acquaint themselves with at least the basics of these important areas of their financial lives. Therefore, without even going into your requirements or details, we are sending you some important material for you to go through, so that you understand the foundation upon which later advice will be given if you decide to avail of our services later.

The material being sent to you along with this mail serves one more very important purpose. You have to form an opinion whether you agree with our investment philosophy. Only if you do, should you continue with us.

Attached to this mail, are three of our basic introductory papers on financial planning and investment. Let us briefly take you through them.

The first paper is a guide to financial planning. Financial planning is like preventive medicine on the financial front. There are certain critical areas of your financial life that you should be aware of, where a few proper steps must be taken. If this is done, you will be able to deal effectively with adversities that may arise from time to time in your financial life. You will also be able to achieve financial freedom sooner than later.

The second paper mentions some good investment strategies for mutual fund investment. The third paper is a guide to equity investment. By no means are we suggesting that you should get into stock market investment right away. However, virtually all advice you receive from stock brokers is wrong and therefore it would be in your interest to have a basic idea of sound stock market investment.

If these papers appear to make sense to you, then we would urge you to go through our detailed PowerPoint presentation on Personal Financial Planning, which is also attached to this mail. This presentation also deals extensively with retirement planning and also answers questions about the quantum of financial assets you must have to retire comfortably in India. If you have any questions thereafter, you can email us and seek our help in drawing up a sound financial plan for your retirement.

Essentially, investment is for 3 purposes. The first is for parking funds or keeping some funds aside to meet emergencies. The concept of emergency funding has been explained in detail in our PowerPoint presentation on financial planning. The second reason why we invest is to earn regular returns. This is an area where most people make mistakes. When you are of an age where you can actively work and earn money, your earnings are your regular income. It would be most unwise to place your savings in further regular returns avenues such as bank fixed deposits.

During your active working life, the vast majority of your savings should go into growth avenues of investment. History has shown that equity and real estate are the only two avenues of investment that have consistently beaten inflation and delivered genuine, wealth-enhancing returns over periods of 10 years or more. If you are not familiar with stock market investments, the right approach would be to invest using strategies such as zero-risk systematic transfer plans of mutual funds, explained in our second paper which speaks about good investment options in the equity and debt markets.

If you want to engage our services for financial planning then we need detailed information about you and your family. This type of information will be sought from you later, depending upon your response to this mail.

Client’s question: First, I do agree with your philosophy in that I do not intend to leave my financial planning entirely in the hands of an adviser. I do have considerable experience in investments here in the US but none in India and am therefore looking for some help

At this point I am interested in something that gives me a regular rate of return with zero risk. Your option of zero-risk Systematic Transfer Plan seems to fall under that but I had some difficulty with the numbers. If I am withdrawing Rs. 1000/- every month from my principal of Rs. 1,00,000/- to be put into a diversified equity fund and assuming a 5% interest on the principal , my principal only earns Rs. 5,000/- whereas I have withdrawn Rs 12000. So there is still some risk (unless the short term interest is 12% or more).

If you can clarify this further, this would help.

Mr. Gerard Colaco: The zero-risk systematic transfer plans are not designed to provide regular returns. They are designed to provide long-term growth in the Indian context, without a risk to capital, by transferring a debt corpus to an equity corpus over a period of approximately ten years. I see that you are interested in an investment that gives you a regular return with no risk. At the moment, the best avenue of investment for such an objective would be a non - repatriable bank fixed deposit.

Such deposits give you a minimum of 9.25% per annum at present, with interest payable quarterly. Some banks may even offer 9.5%. You can invest in these deposits if you are a non-resident Indian or a person of Indian origin, holding an Overseas Citizen of India (OCI) card.

Client’s question: Thank you for your advice. Yes I am looking for an investment with a regular rate of return with minimal risk.

I am already aware of the non -  repatriable CDs option though the interest rates I have come across ie between the 7.00 and 8.00 percent.

Based on this I am assuming that you do not have any other investment related strategies that would that would provide some steady rate of return.

Mr. Gerard Colaco: If you want total safety and a regular return, then yes, I would not recommend anything other than non - repatriable bank fixed deposits at present.

You will have no difficulty in getting rates of between 9.25% and 9.5% from leading banks at present. The present deposit rates are displayed prominently in their websites.

Client’s question: Pardon my saying so - but putting my entire corpus in bank CDs doesn't seem really safe to me (considering what is happening to the banks here in US) – at least in terms of returns.

Let me talk to my brother Mr. XYZ - I just want to make sure there is no communication gap between what I was looking for and maybe what services you offer.

Mr. Gerard Colaco: I'm afraid I do not agree with your email below about deposits in Indian banks. For that matter, I do not agree with what you have stated about US banks either. Let me first deal with US banks. Having lived in the US for an extended period, I am sure you are aware that the Federal Deposit Insurance Corporation (FDIC) was created by the Glass–Steagall Act of 1933. You will be aware that this corporation of the United States Government provided deposit insurance of up to US$ 100,000/- before the Global Financial Crisis of 2008.

Once a bank is FDIC-insured, deposits in the bank are backed by the full faith and credit of the United States government, to the extent of the limit of deposit insurance stipulated by the FDIC from time to time. I hope you know that since the start of FDIC insurance on 1st January 1934, no depositor in the US has lost any insured funds as a result of bank failures.

We have numerous clients as well as relations in the US. We also advise our US clients on their long-term investments, including investments in IRAs Roth IRAs, 401K/403(b) and Roth versions of these pension plans, Keogh plans, CSAs, etc. In the course of our advice, we have always urged clients to have their deposits and accounts only in banks which are members of the FDIC.

We understand that FDIC/insured banks are required to place prominent signs at their offices, stating that they are members of the FDIC and indicating the maximum limit up to which deposits are insured. The good news is that, in the wake of the Global Financial Crisis, FDIC-insured deposits have actually become safer to the extent that the limit of insurance has been raised in 2008 from US $ 100,000/- to US $ 250,000/-.

In India, the situation is different. Bank deposits here are insured only up to Rs. 100,000/-, which is a miserably small amount. But in my opinion, Indian bank deposits are as safe if not safer than the ones in the US. First, Indian banks function in a tightly regulated and controlled environment. Second, bank deposits are so important to Indian investors,that no government will ever dare to allow a bank to collapse with depositors losing money. Let me give you two examples.

About a decade ago the nationalised Indian Bank faced a huge crisis, because of mismanagement and corruption in the bank from its chairman downwards. The government stepped in with financial aid of Rs 1,300 crores and 650 crores in two tranches. Neither did a single depositor lose money, nor did the bank close down. Today, it has revived functions normally, and is a major Indian bank.

My second example is of a private sector bank called Global Trust Bank. This bank grew very quickly to become one of the leading private banks in India. There were a number of scams associated with this bank from 2001 onwards. In 2004 the bank was merged with another bank called Oriental Bank of Commerce. In the process, not a single depositor lost even a rupee.

There are however, a large number of very small co-operative societies that function as banks in India. These are called co-operative banks. These can be extremely dangerous to invest in. There are numerous instances of co-operative banks closing down and depositors’ thereof losing money, but I would challenge anyone to produce a single investor who has lost money in any one of the mainline banks in India.

It is not that banks can’t fail. It is that the number of bank account holders are too numerous and too many of these account holders are voters, for the government to countenance the failure of a major bank in India. That is why I am willing to stake my reputation on the safety of mainline Indian banks.

Let me give you a small list of banks which would be more than enough for any investor to place even large sums in:

Public sector:

Bank of India

Canara Bank
Central Bank of India
Corporation Bank
IDBIBank
Indian Bank
Punjab National Bank
State Bank of India and any of its subsidiaries
Syndicate Bank
Vijaya Bank

Private sector:

Axis Bank
ICICI Bank
HDFC Bank.

It is not that the other banks are unsafe but the list of good banks is quite large and the above sample should be more than enough, even for an individual of very high net worth.

In terms of returns, there can be very wide differences between returns on bank deposits in the US and India. There can also be wide differences in bank interest rates in the same country from time to time. Here, about 5 years back, interest rates on even long-term deposits dropped to 5.25% per annum. Right now, they are in the region of 9.25% to 9.5% per annum on terms of perhaps 2 to 5 years. For senior citizens, i.e. those above 60 years of age, extra interest of 0.5% is paid.

The strategy must be to place fixed deposits for the longest term possible, especially in a high interest rate scenario like the present one. If you do this, you will continue to earn higher interest rates for a good long time even if rates fall after some time. For example, State Bank of India has a 10-year fixed deposit yielding g 9.25%. I have told many of our clients who need to live off interest income to choose this tenure, so that they can lock into these high presently available interest rates for the next 10 years.

Client’s question: I do really appreciate the time taken by you in explain all this to me in detail. Yes I am aware of the FDIC insurance but after the multiple failures of smaller regional banks here in the US post 2008, there were reports that the FDIC did not have enough money to cover all the deposits if even 30% ( I don’t remember the exact number) of all the banks it covered failed.

As per reports it is a pain to get your money out once a bank fails and FDIC takes over (the banks shut down for 2 months or so - accounts frozen until FDIC can get a handle on it etc )

Yes the FDIC increased the insured limit , but it also raised the amount it charges the banks for the insurance - nothing to affect us directly except the banks just pass down those charges to consumers in one form or other .

I do agree with you that the Government would step in to help the FDIC here (or as the case may be in India) in case of any crisis

After 2008 many here have resorted to paying off the mortgage on their house and own a real piece of property than keep money in banks.

I will think over this and decide about what to do. I do have various Term CD's in my NRO account for now - ranging from 3 months to 1 year.

Mr. Gerard Colaco: My first response is that in periods of high interest rates like the present, it would be good to lock into long-term fixed deposits (5 years or more), so that you continue to earn high interest, even if rates are subsequently lowered. For example, presently State Bank of India has a ten year 9.25% FD.

Second, when any FDIC-insured bank fails, it does not mean you can go to the FDIC and walk away with money owed to you. For all claims, there is a process and a waiting period. But the bottom line is that you get your money back. There is a huge difference between getting your money back after say 3 months and losing it entirely or losing a part of it.

Third, the amount with the FDIC to meet claims arising out of bank failures is irrelevant. If you read the FDIC charter, it is a government corporation which on behalf of the US government guarantees repayment of deposits in FDIC-member banks. If money with the FDIC is insufficient, the US government will fund it.

Mr. Harish Rao:

The Client is very much risk averse and a bit sceptical about Indian investments (at this juncture).

Unrelated to this issue, I have been a big fan of Monthly Income Plan (MIP) for the retired. MIPs (growth option only), combined with Systematic Withdrawal Plan (SWP) is a great tax efficient way of getting a guaranteed pay cheque. However many investors are uncomfortable with the thought of eating one’s own capital.

Moreover, if there is one thing that puts me off, it is the high expense ratio. No Asset Management Company (AMC) has been able to lower the expense ratio for either MIPs or Long Term debt funds.

Mr. Gerard Colaco: Your judgement about the client being risk averse and sceptical about Indian investment at the present time matches perfectly with mine. If the client is comfortable with temporary depletion in capital, what I do is invest the entire corpus in either the FT India Dynamic PE Ratio Fund of Funds or the FT India Life State Fund of Funds – The 30s Plan and opt for a systematic withdrawal plan at the rate of 1.25% of the initial corpus, at quarterly intervals. I prefer this to MIPs.

This amounts to a withdrawal of 5% of the initial corpus per annum. This way, not only does the investor get a regular return, but the corpus tends to grow with time. Once in 5 years or so, the withdrawal is reset to 5% of the corpus at that time, thereby enabling a growing income stream that in all likelihood will be higher than inflation.

The asset allocation and re-balancing that is built into these strategies enable a 'smoothening effect' by which the corpus does not diminish by frightening amounts in the event of serious crashes in the stock market.

This method of proceeding will be suggested to client if she continues to seek our advice and eventually gets comfortable with such investments. In the initial stages however, I believe in addressing the clients’ main concern.