What are the risks associated with Fixed Deposit investments?

Credit Risk

Credit risk is the potential that the bank or government defaults on its debt obligations & fails to make the interest and capital payments to you. This is the biggest risk you take on with a fixed deposit.

The likelihood of a South African bank or the government defaulting on its retail deposit obligations is slim. In case of default, South Africa - unlike other developed countries - also does not have a deposit insurance scheme in place - although one such deposit insurance scheme is being reviewed by Treasury. The proposal suggests guaranteeing deposits up to R100 000 for individuals. It is unclear when and if such a scheme would come into effect. But at this stage the government offers no such guarantees and in the case of banking failure your fixed deposits may be at risk.

It is important to bear in mind the possibility of a banking failure before depositing your hard earned money at a bank. Historically, the most recent banks which have failed include Saambou (2002), New Republic Bank (2002), African Bank (2014) and VBS Mutual Bank (2018). In a number of these cases, the Reserve Bank placed the relevant bank under curatorship. In the case of African Bank - SARB picked up issues as early as 2011 and had put the bank under intensive supervision and eventually curatorship. SARB's first priority was securing African Bank's retail deposits. Which they did. After other investors took massive haircuts (/losses) & the banking operations were derisked, the story of African Bank turned out to be a success. It is now a very different bank compared to its 2011 version. African Bank now offers some of the best fixed deposit rates to individuals.

Liquidity Risk

When you deposit your money at a bank for fixed a term and amount, you take on liquidity risk. That is the risk of no access to your funds when you need it. In emergency cases, you are still be able to withdraw your funds. However, this will come at a cost. Banks will charge penalty fees for early withdrawal. These are typically about 10% of the interest rate the account is earning multiplied by the amount of days left to maturity.