State Bank of India (SBI) has started linking its loan and deposit rates for large accounts to the Reserve Bank of India (RBI’s) repo rate. The new interest rate regime is applicable only to savings accounts deposits with a balance of more than Rs 1 lakh, and short-term loans. While this plan is expected to make loans cheaper, some SBI customers will see the interest rate on their savings bank account fall. In such a situation, investors will look at investment avenues with similar return potential. One of the alternatives being suggested by many experts are liquid funds. But are all liquid funds the answer?
What has changed
SBI had announced that it would be linking its savings deposits rates and short-term loans to the RBI’s repo rate from May 1. Now, the interest rate applicable on SBI savings account deposits over Rs 1 lakh as well as that applicable on short-term loans will change automatically every time RBI increases or reduces its repo rate.
This means large SBI savings deposit accounts will earn reduced interest compared to those with lower balances. For instance, the interest rate on savings bank accounts with balances of more than Rs 1 lakh will be 2.75% below the RBI’s repo rate. Since the repo rate currently stands at 6%, the effective interest rate on large accounts works out to be 3.25%. Till April 30, the SBI was reportedly offering 3.5% for deposits up to Rs 1 crore. The rate was 4% for deposits above Rs 1 crore.
Additional read: What Made Liquid Funds Take Exposure To IL&FS Entities
Liquid option care
Liquid funds are one of the options that may be explored by bank FD customers especially those keeping more than Rs 1 lakh. They can keep a lower balance in SBI to enjoy better rates, and shift the excess money to liquid funds. Liquid funds are market-linked debt funds and as such provide no guarantee of principal or interest. However, historically they have delivered 5-6% even more per annum. Plus, liquid funds are more tax-efficient than bank FDs.
But does that mean all liquid funds are an alternative? No. Definitely not. All liquid funds are not safe. In the past one year, we have seen the likes of Quant Liquid Fund, Franklin India Liquid Fund, Mahindra Liquid Fund, Essel Liquid Fund and Baroda Liquid Fund give about 7.5% return (for year ended April 30), but debt problems at major corporates have also meant that some liquid funds have posted NEGATIVE or poor returns. For instance, Principal Cash Management Fund is down 1.8% in the last 12 months. Union Liquid Fund has generated just a 3.6% gain, after similar issues.
Liquid funds have low market risks, but as events of the last few years suggest this product category too can have credit and default risks. So, bank FD investors who are eyeing liquid funds/money market funds should do some due diligence.
* Do not invest money in any liquid fund that takes credit risks and trying to earn higher returns in this segment. Choose liquid funds which avoid credit risks.
* It is important that you choose liquid funds that have investments only in government securities, treasury bills and debt issued by AAA-rated PSU entities.
A liquid fund has to be safe and this can be achieved by investing in the safest assets. This may mean that your liquid fund would not generate 7% or more return per annum. That is okay. Give up some gains for the safety and security of your hard-earned money.
Disclaimer: The article is only for informational purposes. Investors are requested to consult their financial, tax and other advisors before taking any investment decision.