Now that the budget has raised the deposit insurance cover from Rs 1 lakh to Rs 5 lakh, can I finally switch to a bank deposit that offers more attractive rates? Many depositors who are with established banks and have been watching their deposit rates plummet to 6 per cent levels, are asking this question.  

Small finance banks (SFBs) offer more lucrative deposit rates and are well-regulated by RBI too (unlike co-operative banks). So, do they make for a better alternative? Only for investors who can take on higher risk to their capital.        

What are SFBs?

Small finance banks (SFBs) are a specialised category of banks licensed by the RBI to provide loans to borrowers usually neglected by mainstream banks. SFBs are required to lend out at least 75 per cent of their loans to priority sectors defined by RBI, with at least 50 per cent of their loans going to small-ticket loans below Rs 25 lakh. SFBs also cannot lend more than 10 per cent of their capital to a single borrower. Small Finance Bank in India need to be registered with RBI to be covered by deposit insurance. Till date, RBI has licensed just 10 Small Finance Bank in India that are listed here : https://www.rbi.org.in/scripts/banklinks.aspx

To protect depositor interests, RBI subjects SFBs to SLR and CRR (Statutory Liquidity Ratio and Cash Reserve Ratio) rules as commercial banks, requiring them to set aside 18.25 per cent of their deposits towards SLR and 4 percent towards CRR. SFBs are required to maintain a capital adequacy ratio of 15 per cent. Their promoters are vetted for ‘fit and proper’ criteria and are required to be listed within 3 years of reaching a net worth of Rs 500 crore.

Why they’re riskier  

As relatively new kids on the block, Small Finance Bank in India today have balance sheets and financial ratios that look quite good compared to most established commercial banks which are just recovering from the previous bad loan cycle. But depositors must recognise that they still represent a much riskier option than mainstream banks on two counts. One, they focus on economically disadvantaged small-ticket borrowers and unorganised sectors, which makes their loans more susceptible to default. Two, SFBs, even those which have been microfinance institutions for long, operate on a relatively new business model conceived by RBI only in 2014. The resilience of this model is yet to be tested over an entire economic cycle.

Keeping this in mind, it is best to be selective while choosing SFB deposits. Apart from the usual fundamental factors, we used two filtering criteria to identify the less risky options.  One, we shortlisted those with outstanding loan books of Rs 10,000 crore plus and a sizeable deposit base of Rs 5000 crore plus as per their latest numbers to ensure reasonable scale of operations. Two, we decided to go only with SFBs that are already listed on the stock markets given that listed space bring better financial disclosure and greater analyst scrutiny.

Of the 10 SFBs licensed by RBI, 3 meet these criteria – AU Small Finance Bank, Ujjivan Small Finance Bank and Equitas Small Finance Bank. (More are likely to join them in the coming months as they line up IPOs).   

The viable options

Ujjivan Small Finance Bank: With advances of Rs 13,539 crore and deposits of Rs 10,656 crore as of December 31 2019, Ujjivan Small Finance Bank is listed and traded. Originally a microfinance institution, the SFB now focuses mainly on retail and MSME loans. By end December 2019, the bank had gross NPAs of just 0.9 per cent and net NPAs of 0.4 per cent. Its capital adequacy ratio, at 18.8 per cent was higher than the statutory requirement of 15 per cent. The bank’s liquidity coverage ratio (high-quality liquid assets measured against net cash outflows over the next 30 days) at 445 per cent on December 31 2019 (against the RBI norm of 80 per cent) was among the most comfortably placed among peers, thanks to its recently concluded IPO. While the bank offers deposits in multiple buckets, the 1-year deposit is presently the most attractive offering at 8 per cent per annum.

AU Small Finance Bank: With advances of Rs 26,572 crore and deposits of Rs 23,865 crore as of December 31 2019, the listed AU Small Finance Bank is among the largest SFBs, with a focus on retail and MSME loans.The bank had gross NPAs at 1.88 per cent and net NPAs at 1.01 per cent. Its capital adequacy ratio was at 19.28 per cent. The bank’s liquidity coverage ratio was at 95 per cent on December 31 2019. The 12-15 month deposit is presently the most attractive offering 7.85 per cent per annum.

Equitas Small Finance Bank: With advances of Rs 14,615 crore and deposits of Rs 9670 crore, Equitas Small Finance Bank isn’t listed yet (its IPO is expected this year), but its holding company is listed and traded on the public markets. The SFB focuses mainly on MSME and vehicle loans. By end December 2019, the bank had gross NPAs at slightly elevated levels of 3 per cent and net NPAs at 1.73 per cent. Its capital adequacy ratio, at 23.69 per cent was however comfortably higher than the statutory requirement. The liquidity coverage ratio was at 132 per cent. The 1-year deposit is presently the most attractive offering 8 per cent per annum.

Suitability

SFB deposits are not suitable for investors who can take zero risk to their capital. So if you’re an investor looking for a parking ground for your emergency money, a retiree seeking regular income or an investor prioritising capital protection, SFB deposits are not for you. For these investors, post office schemes offer the best combination of returns with safety. SFBs make sense as a diversifier for investors who already have an allocation to post office schemes or leading banks, and are seeking a diversifier with better returns. 

But as long as my SFB deposits are covered by the insurance limit of Rs 5 lakh, can’t you simply risk it? We think not. The history of bank failures in India tells us that it is best not to bet on the prompt receipt of your insurance dues if a bank fails. One, deposit insurance kicks in only after a bank’s license is officially cancelled by RBI. Before this happens, there’s usually a long period of limbo for depositors when RBI and the bank management try out various solutions to rescue it.

Two, data from the Deposit Insurance and Credit Guarantee Corporation (DICGC) tells us that that even after the bank’s license is cancelled, the claim settlement process can take years. In recent times, it has taken 4-6 years before depositors of failed banks received their insurance claims from the DICGC. A higher deposit insurance limit does not solve these problems. Caveat emptor therefore remains a good rule while choosing bank deposits.