Are High Interest Paying Banks Worth The Risk?

First, it was the PMC Bank, then Yes Bank and now Lakshmi Vilas Bank, that has spooked bank depositors. "How safe are the banks in the country?" is a question on everyone's mind at a time when household savings are rising and deposit interest rates falling.

Those who kept cash in their homes and lockers were scared by demonetisation. Those who invested in debt mutual funds now fear closure of these funds after the Franklin Templeton episode.

It is natural to lose confidence in the system when you read about one-crisis-after-another.

High-interest rates lure deposits

Smaller private commercial banks, small finance banks and co-operative banks offer high-interest rates when compared to public sector banks.

In fact, the difference is significant.

Some banks are offering 7 percent interest on savings deposit account when compared to SBI's (State Bank of India) meagre 2.7 percent. Similarly, co-operative banks are offering as much as 8 percent interest on FDs (fixed deposits) while SBI's highest rate on FDs right now is 5.4 percent when locked for 5 to 10 years.

When there is such a wide gap in interest rates being offered, investors are often tempted to go for it.

With markets still highly volatile from COVID-19 effects, lower or uncertain returns on mutual funds, risk-averse investors may consider these FDs in at their local banks.

High risk-high reward situation

The primary reason that small banks offer higher interest rates is to increase their customer base and raise more funds to lend to their borrowers. It is similar to the high interest offered on unsecured debentures, but not as risky.

In the case of both LVB and Yes Bank, the RBI assured that no depositor will lose their money. The central bank has been working on a resolution for a few months and came with the decision to merge the bank with DBS India, primarily to save the money of the depositors.

Although there are restrictions on how much money can be withdrawn by depositors during the moratorium, it could end sooner.

But the point is that the crisis has been averted with immediate amalgamation plan, similar to that of Yes Bank.

Therefore, as a customer, you need to understand that till date, depositors of scheduled commercial banks in India have not lost their money. It will especially not happen in the case of a public sector bank. So even if these banks offer you less interest, they are safe.

As for smaller banks, they are relatively riskier than large banks. PMC Bank, for example, is still looking for investors to revive the bank which has been under a moratorium for over a year after RBI found irregularities that deteriorated the bank's financial health.

Insurance on deposits

All bank deposits, whether savings or fixed, whether at a small bank or a large bank, are insured up to a maximum of Rs 5 lakh for both principal and interest amount.

All deposits of a single customer at all branches are aggregated for the insurance purpose and a maximum amount of up to Rs 5 lakh is paid. Further, this does not mean that you will get your insured amount immediately after a bank fails. It could even take years. This would mean that you will not be able to access your money when you need it.

If you wish to make your deposits, you can limit it to around Rs 4 lakh for the insurance to also cover interest amount.

Ultimately, investments like equity and debt funds are way riskier; offering no guaranteed returns and no insurance cover. In comparison, small bank FDs are safer but if you do not wish to take on higher risk, you can choose to lock the FD for a smaller tenure like one year.

Disclaimer

The article is purely informational and is not a solicitation to buy, sell in securities mentioned in the article. Greynium Information Technologies Pvt Ltd, its subsidiaries, associates and the author do not accept culpability for losses and/or damages arising based on information in this article.

About the author

Olga Robert is an M.Com graduate covering equity markets and personal finance for nearly three years. Her interests include tax planning, equities, DIY personal finance management and government schemes.