Perform these checks before investing in bank fixed deposit

One of the most popular fixed income options among individual investors is fixed deposits. That being said, what are the checks investors should do before investing in bank FDs? Let us investigate. 

Most parents and grandparents urge us to register a PPF account and FD (Fixed Deposit) with banks once we begin earning money. There is no question as to why they are drawn to FD investments.

FDs were able to outperform inflation at the time. However, with declining interest rates, it is no longer viable to outperform inflation with post-tax returns on FDs. These days, even we have witnessed institutions declare bankruptcy.

To promote retail investor trust, the finance minister increased the depositor's insurance sum from Rs 3 lakh to Rs 5 lakh in the Union Budget. The important point to note is that this coverage applies to all bank FDs on an aggregate basis. If you want to invest in bank FDs, here are a few things you should look at before you do so.

Profitability Ratios

Profitability ratios assist to assess a bank's ability to produce income to cover its costs. If the bank continually fails to cover its costs, this is a red flag.

The profitability ratios to look for are as follows: 

1. Return on Asset (ROA) is computed by dividing net income (loss) by total assets. This ratio tells us how lucrative the bank's total assets are.

2. Return on Equity (ROE) is determined by dividing net income (loss) by equity. This ratio indicates how lucrative the bank's equity is.

3. Interest income on loans is computed by dividing loan interest income by the total loan amount. This ratio might help you determine how profitable the bank's gross loans are.

Capital Adequacy Ratio

This is one of the most important ratios to look at before investing in bank FDs. The Capital Adequacy Ratio (CAR) is a measure of the bank's available capital. This is often used to safeguard depositors. It is determined by dividing the total of Tier 1 and Tier 2 capital by the risk-weighted assets.

The bank doesn't have to stop operating for Tier 1 capital to absorb the losses. Tier 2 capital can sustain losses in the case of a winding-up and so offers depositors a lower level of protection. Risk-weighted assets aid in determining the minimum level of capital required by a bank to minimise the risk of insolvency.

As per Basel III, the minimum CAR that a bank must maintain is 8%. The minimum CAR including the capital conservation buffer is 10.5%. Having said that, the Reserve Bank of India (RBI) prescribes the minimum CAR to be 9%.

Liquidity Ratios

Liquidity is one of the most important things that banks should keep on hand at all times in order to cover any withdrawals. These ratios assess a bank's capacity to satisfy its short-term obligations.

The liquidity ratios to look for before investing in bank FDs are as follows:

1. Short-term funding ratio is computed by subtracting liquid assets from short-term funding. This addresses the issue of whether the bank has enough liquid assets to deal with short-term debt.

2. Loans to deposit ratio is determined by dividing loans by deposits. This ratio must be less than 100%.