4 things to know about small business bank deposits

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It’s not wrong to wonder when a lender offers a higher rate for deposits compared to the industry average. But don’t jump to the conclusion that something is wrong there to offer higher rates. It is important to examine the reasons for the higher rate rather than rejecting the option. The case in point is that of the small financing banks or SFBs. Here we try to dispel some concerns about taking out a Fixed Deposit (FD) with SFBs and what you need to do to make investing a worthy experience.

Risk-reward

Most SFBs offer an interest rate (RoI) of 7-7.25% on deposits for a term of 12 months. This is at least 70-100 basis points (bps) more than what big banks such as ICICI Bank, Axis Bank and Kotak Mahindra Bank offer. The difference in return on investment between SFBs and public sector banks could reach 150 basis points. This should inspire you to consider locking up money with SFBs as term deposits.

Don’t resist the temptation, especially if you’re holding back for bank security reasons. Like any other regular commercial bank, SFBs are also RBI regulated entities and deposits up to ₹5 lakh are covered by the Deposit Insurance and Credit Guarantee Corporation (DIGCC). But SFBs offer a higher return on investment because their prima facie business model can be riskier than big banks. Per term, 75% of their loans must be for the priority sector (agriculture, small businesses, etc.) and 50% of their loan portfolio must consist of loans amounting to ₹25 lakh or less. Consequently, the proportion of unsecured loans in an SFB can reach 50-75% compared to less than 30% for large commercial banks. The quality of their loan assets puts them in the risk zone. That said, SFBs take this risk into account by deploying their loans at a premium of at least 150 to 250 basis points over what banks normally offer. For example, if a Bank of Baroda home loan is at 6.9%, the SFB rate could be higher than 8.5%. The leeway to price risk gives them the ability to price their deposits also at a premium to the industry average. Moreover, these banks have only been around for 5-6 years and are in the early stages of mobilizing their deposit base. So, until they reach a point where they enjoy strong customer loyalty and a large deposit base, they will distribute FD at high interest rates.

How to select the bank?

Whoever offers the highest interest rate goes with them. Whether listed or not, the financial statements of all SFBs would be available on their website. To allay your fears about the bank’s stability, research its gross non-performing assets and loan and deposit base growth over the past fiscal year and over a three-year period. Also check out core business growth measured as net interest income. Since SFBs operate on a small base, their growth rates tend to be higher than large banks; in the 25 – 35% zone for loans and deposits. Net interest income growth of 20-25% is a good measure.

What may bother you in the meantime is the bad debt pool. Since the SFBs, with the exception of the AU SFBs, operate in the microfinance space which was extremely vulnerable to asset quality shocks during the pandemic, their NPAs are well above average on 5 years. As activity normalizes, this metric should improve. That said, since all SFBs are well capitalized, high NPA levels should not be of great concern from a filer’s perspective.

How to invest?

Although all the banks have improved their technological capabilities, if you plan to use only an FD and not its other banking products, place your money in the SFB which has a branch near your residence or place of work . The adoption of technology and the quality of SFB’s call centers are still improving. Therefore, holding a physical FD receipt versus online proof may work better, especially in an emergency. Also try to familiarize yourself with the people at the branch, so they can help you if needed.

How much to invest?

If SFB isn’t the first port of call for your financial emergencies or the bank you’d rush to in case of an SOS, don’t put all your savings in the bank. Until you are familiar with its processes and feel comfortable with the SFB in terms of convenience and stability, it is best to start the FD with only the investable surplus that can earn you a return on higher investment.

Again, if you want to feel more protected, split the deposit into smaller sums and make sure none of them exceed ₹5 lakh, so that all the money is secured by DICGC cover. Lately, the difference between 12-month and 36-month fixed term deposits narrows to 0.5 – 0.75%. Therefore, until you trust the bank, opt for shorter duration FDs and quickly roll or cash them according to your needs as they mature.

Published on

July 16, 2022

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