Fixing Returns

INVESTORS in fixed deposits (FDs) never had it so good. With the Reserve Bank of India (RBI) lifting the interest rates on FD borrowings of select non-banking finance companies (NBFCs), annual effective yields have jumped to 27.73 per cent (Kotak Mahindra), 29.77 per cent (Reliance Capital) and 30.68 per cent (Apple Industries) on five-year deposits. Even on one-year deposits, effective yield has touched 21 per cent (Enarai Finance). Last week, after some dilly-dallying, Sundaram Finance announced a hike in annual rate from 15 to 17.5 per cent on three-year deposits, giving investors the added option of premature renewals.

 Not all NBFCs, however, are sharing the enthusiasm of investors. Now that the rates are theirs for the asking, a lot of prominent players have declared their intention of either not revising rates or of adopting a wait-and-watch stance.

What has stumped most NBFCs is the aggressive rates announced by the first movers in the market. "The market has overreacted. A Reliance may have the wherewithal to leverage the cost of funds by borrowing abroad besides other avenues of funding, but for an average company, where are the assets to service such high-cost borrowing? There will be an asset-liability mismatch," says Deepak Kapoor, vice-president, 20th Century Finance. The free interest regime obviously has a cost-of-entry attached to it which is causing concern to the industry.

First, with inter-corporate deposit returns poised to go down and bank refinancing at rates between 17.5 to 23 per cent for top-rated NBFCs and the repeated pronouncement by the RBI governor on his commitment to bring down interest rates, these companies are apprehensive that any hike in FD rates will squeeze their margins.

Second, in the new regime, companies can ill-afford to have the large chain of brokers, sub-brokers and clients that have traditionally driven the FD market. They would have to service investors directly. This would mean a big outflow of funds on setting up an infrastructure network. Third, there’s a possibility that some investors may refuse to convert to the clean cult, preferring to stick to the traditional modus operandi: liberal doses of upfront incentives. "Why would any investor be attracted by the new ‘ostensibly’ higher rates when he is getting the same returns, if not more, from the same company by way of upfront commission? He would rather take whatever is coming upfront than wait for a higher return on the date of maturity after several years," says Anil Chopra, chief executive, Bajaj Capital.

 Exaggerated fears? Or the pains of moving over to a free interest regime? A bit of both. The fear of high interest rates squeezing profits may be unwarranted considering most companies have anyway been giving upfront commissions to woo customers. "The RBI has legalised the process," says Ajay Raina, assistant vice-president, Apple Industries. Apple has been among the first to announce an interest rate hike on FDs. "We hope to maintain spreads of 4 to 5 per cent by lending activities like car and truck finance where the volumes would give us the spreads," says Raina. "There are enough avenues like consumer finance where the rates of return could be between 36 to 40 per cent or investment in unlisted shares which could give returns in excess of the borrowing rates of NBFCs," agrees Dhruv Prakash, president, DCM Financial. FD rates of around 20 per cent as announced by the likes of Reliance need not cause alarm.

Even assuming that the cost of borrowing rises as companies set up an independent infrastructure to service investors directly, many companies view it as the inevitable cost of developing the market. "The new realities of the market dictate that intermediaries have to be cut. Companies have to come clean and talk to investors across the table instead of passing under-the-table incentives," says Prakash. Apple would pay only a statutory brokerage of 1 per cent for one year, going up to 2 per cent for three years and more. "We plan to shift strategy from being a broker-driven company to a direct marketing one," adds Raina. Reliance Capital has followed suit. Brokers, surprisingly, agree. "The business of incentives has led to competition to hook investors not on the basis of better marketing or service but on greater incentives. This is leading to a squeeze in broker margins while creating dirty undercutting," admits Chopra. Instead, they are prepared to accept steady and regular, even though reduced, brokerage.

Investors are approving too. "Earlier, my ability to get a 17 or 18 per cent return would depend on my negotiating skills and ability to wrench the maximum out of the broker. Now with the same returns available off the shelf, I would rather buy that than haggle," says R. Parameshwaran, a retired government official. Besides, says Prakash: "There has been no innovation in FD products because there was no flexibility in interest rates. Even an add-on insurance policy has been traditionally viewed by the RBI as part of the cost of the FD. With free rates, we’d be able to offer more investor-friendly schemes."

The FD market is readying for a lot of action. In the short run, companies may have to pay a wee bit more. Brokers may pocket a little less. But investors definitely stand to gain from the dynamism the finance companies will infuse in the market.