How to ensure financial safety when your bank is in crisis?

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The impact of the Covid-19 pandemic on banks was relatively exclusive in comparison to other industry trends. There has been minimal shock since the pandemic struck the country in March of 2020. Banks were not impacted due to enough regulatory support in terms of recognition of Non-Performing Assets (NPAs) as well as financial support from the government to shore up the capital. However, banks are as vulnerable and crisis-prone as any other investment tool but somehow one doesn’t believe it until lightening strikes.

“There will always be stronger banks and weaker banks. Depositors need to make choices on the trade-off between stronger banks that will tend to offer lower deposit rates especially with ample liquidity availability and weaker banks that may find it more difficult to raise capital or lend to more risky segments in both corporate and retail segments,” Vishal Dhawan, financial planner and founder at PlanAhead Wealth Advisors said.

PSU banks, private sector banks and co-operative banks

While there is no such thing as risk-free banking, what steps can an investor take to keep those risks at bare-minimum? To understand this, the Indian banking sector needs to be divided into 3 distinctive segments – PSU banks, private sector banks and co-operative banks.

“Going by the past track record as well as various acts of the Government and the regulators, irrespective of the financial situation of the bank concerned, the PSU segment is considered safe for the depositors. PSU banks are seen as an extension of the Government from a risk perspective, thus Government can’t afford to have a PSU Bank default, as the ramification could be loss of trust in the system,” veteran market analyst Ambareesh Baliga said.

Though private sector bank depositors need not be given similar safety net, the Government has come to the rescue of such banks directly or indirectly by finding a suitor to ensure that depositors are safe.

Depositors have gone through a fair share of uncertainty with respect to troubled private sector banks. But the end results have been more or less satisfactory. We have witnessed Global Trust Bank getting merged with Oriental Bank of Commerce (now merged with PNB), Yes Bank being rescued by State Bank and others in the Banking system, Lakshmi Vilas Bank being taken over by DBS after going through a period of moratorium, possibly giving the depositors sleepless nights.

“A depositor should prefer PSU Banks as well as the large private sector banks where there isn’t an iota of doubt about the financial soundness of the bank. One should realise that the additional 100-150 bps which the weaker private sector banks give for fixed deposits could be disturbing at times, in case they go into moratorium,” Baliga said.

Co-operative banks should not be a natural choice, unless one is compelled due to regulatory requirements. For example, many housing societies in Maharashtra had their accounts with PMC Bank which went into moratorium. Co-operative housing societies in Maharashtra mandatorily need to keep their funds with co-operative banks and the audited accounts of PMC Bank did not reveal the pain, unless one had inside information.

How to ensure financial safety?

Check the credibility of the provider before you invest. This means a complete background research to see if the bank has been in the news for reasons such as high NPAs or governance issues. As per Adhil Shetty, CEO at BankBazaar.com, “As per RBI norms, Indian scheduled commercial banks are required to maintain a CAR of 9% while Indian public sector banks are emphasized to maintain a CAR of 12%. Look for a minimum capital adequacy ratio (CRAR) of 10.875%, profitability numbers, and percentage of NPAs. A decline on any of these factors could mean that the bank is facing difficulties.”

The PlanAhead CEO advised customers to avoid chasing highest rate deposits, understand which segments the bank is lending to and associated risks before choosing a bank. Additionally, one shouldn’t put all their money into one bank just because of easier access or convenient branch timings.

“Have two bank accounts with strong banks is the starting point and you should do the same with your savings, current and bank deposits,” said Dhawan.

It is essential to remember that practically no bank in India has collapsed since 1960. Even in case of stressed co-operative banks as well as private banks, there is still light at the end of the tunnel in the form of mergers.

“The RBI has constantly reiterated that it will not let any bank to collapse, and customers’ interest has always been a priority. So the chances of banks collapsing back to back is very low. That said, funds from each bank would be insured separately. So in the event of such collapse, your deposits of up to Rs 5 lakh would be covered by DICGC in each case. This includes deposits in all scheduled commercial banks including branches of foreign banks functioning in India, local area banks and regional rural banks, and all co-operative banks,” Shetty pointed.