Arvind Rao, founder, Arvind Rao and Associates
State Bank of India’s (SBI) fixed deposit rate for one- and 10-year tenures is 6%. Small finance banks are giving deposit rates that are higher by 2.5-3 percentage points. Investors need to realize that with higher returns, there are higher risks. Anyone taking a bet on the FDs of small finance banks should restrict their exposure.
We are in uncertain times at present. There have been defaults even on papers that were rated triple-A (AAA). Until this debt crisis settles down or consolidates, which can take up to nine months, investors should take limited exposure to small finance banks FDs.
In the past, depositors had rushed to co-operative banks as they offered higher returns. After the Punjab and Maharashtra Co-operative Bank fraud, investors have lost faith in this category of banks. The same can happen if there is a problem with even one small finance bank. So it’s better for depositors to strike a balance. It’s difficult to say the kind of exposure one should take to these banks. Don’t put above ₹5 lakh in one small finance bank and don’t invest in more than four banks.
Diversify your FD investment among various types of banks
Small finance banks are similar to commercial banks. They are also regulated by the Reserve Bank of India (RBI). They give out low-ticket loans. About 75% of their total lending has to be to the priority sector, which helps in financial inclusion. There are challenges in evaluating the creditworthiness of the section of the population they primarily cater to. Of course, they would have a credit policy and mechanisms to evaluate the creditworthiness. Due to the profile of the customers, these banks are riskier than large commercial banks. This may be why they give higher FD rates.
But they are under RBI and have the compliances that scheduled commercial banks follow. They, therefore, cannot be ignored.
A person can invest some money into these banks, but I would advise them to be cautious. An investor ne to diversify his FD exposure as well. Of the total funds earmarked for FDs, an individual should not put more than 20-25% in FDs of small banks. The rest can be allocated to FDs of large banks, high-quality non-banking finance companies and debenture and perpetual bonds.
Investors should definitely consider fixed deposits from small finance banks as a part of their overall FD exposure. The higher differential yields along with a higher insurance cover make a compulsive case for their inclusion.
Senior citizens will especially not want such worries related to their money as safety is their primary concern. They need to be more conservative in their exposure. But excluding these FDs would be a loss of opportunity. Investors, therefore, need to strike the right balance.
There are higher rates for slightly longer-term FDs with these small finance banks, but this also with higher risk. Hence, it would be appropriate to restrict the exposure to deposits over three years.
Nishant Agarwal, managing partner and head, family office, ASK Wealth Advisors
Choose debt funds if your horizon is three years or longer
The perceived safety in the name “bank” is often enough for a layman investor to not differentiate between different types of banks—public sector, private sector, small finance or co-operative and the risks associated with each. Higher FD rates coupled with proximity, service quality and relationship with the staff are usually are the key factors to choose a bank for FDs.
With scheduled banks offering 6.25-6.50% currently, offers of 8-9% by some small finance banks look attractive. Some of these banks have a good credit rating, sound lending practices, experienced team and good financial metrics. Also, all small finance banks need to have more than 50% of the portfolio in loans and advances of up to ₹25 lakh, making them less susceptible to large exposures to a single promoter group or project and hence reducing concentration risks.
But from a risk mitigation point of view, it makes sense to have FDs in more than one bank. Also, money meant for three years or longer can be invested in safe debt mutual funds, which also offer diversification and tax benefits.