Small finance banks (SFBs) offer higher interest rates on their fixed deposit (FD) schemes compared to large commercial banks to attract more customers. Some small finance banks are even offering rates of up to 9.5% to senior citizens on FDs, which much higher than those offered by major banks. This raises the question: why do small finance banks offer higher interest rates despite having less liquidity than major banks, and is it safe for customers to invest their deposits in these banks?
But before moving ahead, it’s important to understand what SFBs are and what their objectives are.
Small finance banks have been authorised by the Reserve Bank to function as specialised banks for particularly low-income individuals and underserved communities and offer them financial services. SFBs primarily focus on microfinancing, micro-enterprise services, and other basic banking facilities.
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In addition to these, such banks also deliver essential services like savings accounts and remittances to those who lack access to traditional banking systems. By doing so, SFBs bring such individuals under the banking system net and enable them to take part in economic growth opportunities.
Now, let us address the primary concern that most people have regarding the safety of their deposits in a small finance bank. According to Manish Priyadarshi, Partner at Grant Thornton Bharat, investing in a fixed deposit with an SFB can be a good option for customers. However, he emphasises the importance of conducting due diligence to evaluate the bank’s financial health before making any investment.
Key things to keep in mind when investing in an FD in small finance bank
The quantum of deposits that a bank can mobilise is directly proportional to the level of trust that is perceived by the customers, says Priyadarshi. SFBs, which are currently offering higher interest rates compared to their universal banking counterparts, present an attractive opportunity for depositors.
He highlights two critical reasons why FDs in SFBs can be considered safe:
Regulation: SFBs are also RBI-regulated entities just like universal banks. This ensures that these banks operate under stringent guidelines, providing a measure of trust and security for depositors.
Deposit Insurance: Deposits are insured under the Deposit Insurance and Credit Guarantee Corporation (DICGC), which provides equal insurance coverage of up to Rs 5 lakh per depositor per bank. This insurance guarantees a safety net for small depositors.
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However, Priyadarshi advises caution and recommends evaluating specific parameters to ensure the financial health of the bank before investing:
Capital Adequacy Ratio: A strong Capital Adequacy ratio clearly indicates the bank’s capacity to absorb losses, thus reducing the overall risk of default.
Non-Performing Assets (NPAs): Sustainable levels of NPAs are crucial, as they directly impact the bank’s liquidity position and risk of default.
Management Stability: An experienced and stable management team with proper succession planning is vital, as the absence of strong governance can lead to inconsistent performance.
Credit Rating: The credit rating represents the overall financial well-being of a bank, considering all tangible and non-tangible factors.
In summary, placing an FD in an SFB is a lucrative option given the higher interest rates than universal banks; however, one must exercise due diligence in evaluating the financial health of the bank before investing, concludes Priyadarshi.
By focusing on these evaluation parameters, depositors can make informed decisions and take advantage of the higher returns offered by SFBs without compromising the safety of their investments.