It’s not wrong to question when a lender offers higher rate for deposits compared to the industry average. But don’t jump into a conclusion that something must be wrong there to offer higher rates. It’s important to look into the reasons for the higher rate rather than dismissing the option. The case in point is small finance banks or SFBs. Here we attempt to dispel some concerns on signing up for a fixed deposit (FD) with SFBs and what you should do to make the investment a worthy experience.

Risk-reward

Most SFBs offer 7 – 7.25 per cent rate of interest (RoI) on deposits for a 12-months term. This is at least 70 – 100 basis points (bps) higher than offered by large banks such as ICICI Bank, Axis Bank and Kotak Mahindra Bank. The difference in RoI between SFBs and public sector banks could be as high as 150 basis point. This should tempt you to consider locking in some money with SFBs as fixed deposits.

Don’t resist the temptation, especially if you’re holding back for concerns around the safety of the bank. Just like any other scheduled commercial bank, SFBs are also RBI-regulated entities and deposits up to ₹5 lakh are covered by Deposit Insurance and Credit Guarantee Corporation (DICGC). But SFBs offer higher RoI because their business model on the face of it may be riskier than larger banks. By mandate, 75 per cent of their loans should be towards priority sector (agriculture, small businesses and so on) and 50 per cent of their loan book should be comprised of loans with ticket sizes of ₹25 lakh or less. Therefore, the proportion of unsecured loans in a SFB may be as high as 50 – 75 per cent as against less than 30 per cent for large commercial banks. The quality of their loan assets positions them in the risky spot. That said, SFBs price in for this risk by rolling out their loans at least 150 – 250 bps premium to what normally banks offer. For instance, if a home loan from Bank of Baroda is at 6.9 per cent, SFB’s rate could be upwards of 8.5 per cent. The leeway to price in risk gives them the room to price their deposits also at a premium to industry average. Moreover, these banks have been in existence for just around 5 – 6 years and are in the early stages of mobilising their deposit base. So, until they reach a point where they enjoy high customer stickiness and a large deposit base, they will dole out FDs at high interest rates.

How to select the bank?

Whoever offers the highest interest rate go with them. Whether listed or unlisted, financials of all SFBs would be available on their website. To dispel your fears around the bank’s stability, look out for their gross non-performing assets and how the loan and deposit base has grown in the last fiscal year and over a three-year time period. Also check for the core business growth measured as net interest income. Given that SFBs operate on a small base, their growth rates tend to be higher than the larger banks; in the 25 – 35 per cent zone for loans and deposits. Net interest income growth of 20 – 25 per cent is a good measure.

What may trouble you in the interim is the pool of bad loans. Given that SFBs, barring AU SFB, operate in the microfinance space which was extremely vulnerable to asset quality shocks during the pandemic, their NPAs are way above the 5-year average. As the business normalises, this metric should improve. That said, since all SFBs are well-capitalised, high NPA levels need not be of much concern from a depositor’s perspective.

How to invest?

While all banks have upped their technology capabilities, if you are looking at only availing a FD and not its other banking products, put your money in the SFB which has a branch within the vicinity of your residence or workplace. The technology adoption and quality of call centres of SFB are still in the process of refinement. Therefore, holding a physical FD receipt versus an online proof may work better, especially at times of emergency. Also, try to familiarise yourself with people at the branch, so that they could help you in times of need.

How much to invest?

If the SFB isn’t the first port of call for your financial emergencies or the bank that you’d rush to if there is an SOS, don’t put all your savings in the bank. Till you familiarise yourself with its processes and grow comfortable with the SFB in terms of convenience and stability, its better to start the FD with only the investible surplus which can earn you a higher RoI.

Here again, if you want to feel more protected, break the deposit into smaller sums and ensure that none of them cross ₹5 lakh, so that all the money is secured by DICGC cover. Lately, the difference between 12 months and 36 months tenured fixed deposits is narrowing down to 0.5 – 0.75 per cent. Therefore, till you feel confident about the bank, opt for shorter-tenure FDs and promptly get them rolled over or encashed based on your requirements as and when they fall due.

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