Small Finance Bank Deposits: Are they safe? Can I invest? Plus other FAQ

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Here is a FAQ on Small Finance Banks: Are they safe? Can I invest in their fixed deposits? How are they protected? What are the safeguards? What are these banks for? Let us find out.

Small Finance Banks: Are they safe? Can I invest? Plus other FAQ

A FAQ on Small Finance Banks

  1. What are they? Small Finance Banks are Banks licensed by RBI under section 22 of the Banking Regulation Act, 1949.
  1. Why? Certain sections of the society were not fully catered to by the existing banks. These sections of the society were neglected and kept out of the financial system due to lack of availability of basic identity documents, literacy etc. Hence, differentiated banks were intended to be set up which can be primarily responsive to the local needs.

Hence, the objective of these banks is to:

  • Promote Financial Inclusion.
  • Be the last mile lender by giving loans to Small Businesses/Industries, Small Farmers, Un-organised sector/migrant workforce & the underprivileged.
  1. Where can you find them? On Google, of course! 🙂  However, 25% of branches of these banks have to be in unbanked rural areas (population up to 9,999 as per the latest census).

These banks pre-dominantly open branches in the states where they hold some existing customer base as many of these banks were Micro Finance Institutions earlier.

  1. When? 2015:- RBI granted a license to 10 applicants out of 72. Click here to view: – Applicant List, Selected List.
  1. What can they do & what they have to do? They can:
  • Conduct Basic Banking activities – such as accepting deposits & lending.
  • Sell mutual funds, insurance products, pension products, etc. with the prior approval of the RBI and after complying with the requirements of the regulator for such products. They are allowed to do this as these are non-risk, simple financial activities, not requiring any commitment of own fund.
  • Conduct foreign exchange business for its customers.
  • Convert to a full-fledged bank.

They have to necessarily:

  • Cater to-Small Businesses/Farmers, Unorganized and migrant Labourers.
  • Give 50% loans to MSME (Micro, Small & Medium Enterprises)
  • Ensure at least 75% of their total loans is given to the Priority Sector.
  1. What they cannot do?
  • They cannot deal with sophisticated financial products.
  • They cannot set up subsidiaries to undertake non-banking financial services activities.
  1. How should they work?

High use of technology & Low cost:-

Existing banks had to migrate to new technology as they may be as old as 100 years.

However, since these banks are being setup after 2015, RBI specifically wanted these banks to make high use of technology right from the beginning and keep the operating costs low. Hence, you would these banks to have good Digital Services and their banking outlets/branches may be small.

Should you invest in these small finance banks?

Well, there’s always more than what meets to the eye. There may be additional conditions attached.  If you are in Mumbai, there are high chances that you may have seen huge hoardings of the following ad:

Typical small finance bank ad

The bank in question offering 9.6% to Senior Citizen had:

  • a lock-in of 3 years (ie non-callable deposits). Premature withdrawal is not allowed under any circumstances. One of the reasons they give such high-interest rates is because of the “lock-in” for a fixed time.
  • The rate is applicable for deposits above Rs. 15 lakhs.

Ask yourself the following questions:

  • Am I ok with giving my money to a new player? They are yet to show their strengths in testing times.
  • If there’s a Lock-in, am I am ok with it?

You may not be able to withdraw the deposit under any circumstances except in case of death or in-case of order from statutory/regulatory body subject to approvals.

  • Do I like to have Customer service which is Digital or which is offline?
  • Can I get an overdraft against such deposits?
  • Am I ok with giving money to someone who will give my money to other people (by way of loans) & knowing the fact the loan expertise in these banks is still evolving.
  • Am I okay with a bank that has a mandate to lend to small businesses, many of them can fail at an alarming rate?
  • If the bank fails, do you have the time to wait for the money to be returned back through the DICGC Insurance? Read more about this: What happens if my bank fails? All about Deposit insurance (DICGC)

Official Liquidator of the Bank makes application for the claim within 3 months after being appointed and DICGC makes the payment within 2 months). In reality, the timelines can be very different (years even, see above post for examples)

DO NOT INVEST YOUR: Emergency fund in ANY “non-callable/lock-in” FDs.

It is possibly an option that Cooperative Societies, Trusts, Partnerships, NGO and Private Limited Organisations can consider.

How safe are these small finance banks?

The regulators keep a close watch on them. There are multiple checks to ensure that they are run in a professional manner.

  • At least 50 per cent of its total loans should be less than Rs. 25 lakh.
  • Further, the maximum loan size to a single and group borrower would be restricted to 10 per cent and 15 per cent of its capital funds, respectively. Hence, you will not have a single borrower who can take loans of 9000 crore or 11000 crore.
  • For the investor with a number bug, you can look at the banks Liquidity Coverage Ratio.

Liquidity Coverage Ratio (LCR) ensures that the bank maintains sufficient High Quality Liquid Assets to survive acute stress scenario lasting 30 days. The RBI requires SFB (Small Finance Banks) to increase the Liquidity Coverage ratio in the following phased manner:

liquidity coverage ratio of small finance banksThe LCR maintained by the bank can be found in the Disclosure section of the banks’ website.

  • All prudential norms and regulations of RBI as applicable to existing commercial banks including the requirement of maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
  • The banks are run by Promoter/Promoter groups who are found to be ‘fit and proper’ with a sound track record of professional experience or of running their businesses for at least a period of five years.
  • RBI mandates these banks to be listed within 3 years of operation. Listing of Banks ensures that additional system checks kick in.
  • Minimum paid up equity capital of such banks should be Rs.100 crore.
  • contribution by the promoters should be 40% which can be brought down gradually.

What happens if I invest Rs.15 lakh in their FD and they go bust?

Despite all of the above regulations, it can/may happen!! If it does, since these banks have deposit insurance up to Rs. 1 lakh can be claimed back. However, this can take months to years and therefore cold comfort. See: What happens if my bank fails? All about Deposit insurance (DICGC)

I want to invest, but I have fears & doubts. Koi rasta/jugaad?

The above-linked post on deposit insurance has examples of how the money can be divided among family members to ensure most of the invested amount is eligible for deposit insurance. However is it worth the risk? The headache and the wait? Definitely no.

RBI deputy governor KC Chakrabarty rightly said:

“Finance always exploits. I laugh when people say finance helps. Small finance banks need to be sympathetic to their customers if they want to remain relevant.”

Summary

I go for a walk each evening (after uploading the day’s youtube video) and love walking around busy streets filled with small shops and roadside hawkers. In the last four years, more than ~ 20-25 small businesses shut shop or replaced by other businesses. Almost all of them would have borrowed money (form local loan sharks). Since a small finance bank cannot do what a loan shark would do upon default, their business model does not appear to be strong enough to trust them with my money. I think they will be under severe pressure if many of their borrowers fail to pay. Therefore personally, I will not lend to small finance banks for a small benefit. How about you?

This post was written in collaboration with a commissioned content writer from the banking industry.

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8 Comments

  1. Hi,

    I am sorry to say this but this is scaremongering. First and foremost they are banks under the supervision of the RBI. They have to follow all the prudential norms. They have a far better track record as MFIs recovering money WITHOUT collateral. Far superior some times than the so called big banks. They were not born yesterday. After reading this article, I am really skeptical about the author and his credentials.

    1. It’s your part too to know financial health of small finance banks. For eg. Jana small finance bank is one of the highest NPA holder across all types of banks. All the rating agency has given it negative ratings. Before investing google bank’s ratings and NPAs atleast. 👍

  2. i have deposited in esaf small bank . interest was 9 percent. good service.now am getting home service . they will come to my place and do the job.safety too not bad . better than our big nasty sbi. y not try them?

  3. Very informative and clear article! Sir What is your choice between small finance bank fd vs debt mutual funds?

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