Parking money in small finance banks: Know the math

In this age of low interest rates, a section of banks still offers 7%-8% interest in fixed deposits and recurring deposits and 5%-6% in savings accounts. These banks are called small finance banks (SFB), but they are not small in nature. There are about a dozen of SFBs operating across the country. But how can they afford such interest rate is often a question in the minds of customers. In the view of the relatively higher interest rates, some also think about the safety of the money invested with these banks.

Decode SFB

Small Finance Banks is a specific segment of banking created by Reserve Bank of India under the guidance of Government of India with an objective of furthering financial inclusion by primarily undertaking basic banking activities to un-served and undeserved sections including tiny business units, small and marginal farmers, micro and small industries and unorganised entities. These sectors are treated as the priority sector of SFB banks.

Like other commercial banks, these banks can undertake all basic banking activities including lending and taking deposits. These banks are fully monitored and follow every guideline of RBI. So, these banks are safe and regulated, said Rajen Nagar, President, All India Bank Employees’ Association.

High interest rates

It is a common psyche among us to park our money in popular institutions. Therefore, most of us would prefer to put our money in banks with more customers than in those with fewer customers, said Arvind Agarwal, a tax professional.

This tendency turns big commercial banks into entities with huge cash deposits, Agarwal added. Considering the uncertainty in the financial markets, investors often rush to move their savings to big commercial banks and post offices. For an example, SBI offers 5.3% in three-year FDs, where SFBs like Jana and Ujjivan offer 7.25% and 6.75% respectively.

SFBs were not very popular even a couple of years ago. But the picture has changed a lot since 2019. The SFBs don’t have a vast account base like large commercial banks. Therefore, they offer lucrative deposit rates to attract potential customers to build deposits. As they gain ground and their cost of funds goes down, the interest rates might also dip in future.

“The maths is simple. SFBs have less deposit and so they offer higher interest rate to attract more and more people to build there corpus. When they build a big corpus their interest rate would come down,” said a member of state level bankers’ committee, requesting anonymity.

All SFBs come under strict RBI guidelines and are monitored by the central bank like any other big commercial bank. The deposit insurance for Rs 5 lakh is applicable to them as well. So, if anything untoward happens, depositors would get that amount within 90 days.

But considering the current uncertain scenario, one should not park more than 20% of his/her savings and investment in an SFB. To minimise the risk, one has to diversify his/her savings and investments. “This 20% formula is not only for SFBs, but also for all banks. Do not put more than 25% of your savings/investment in a single bank,” advised Nilotpal Banerjee, a financial planner based in Kolkata.

According to RBI, the minimum paid-up equity capital for a small finance bank shall not be less than Rs 200 crore.

List of SFBs

There are 11 SFB currently operating in the country. These are: Ujjivan Small Finance Bank, Jana Small Finance Bank, Equitas Small Finance Bank, AU Small Finance Bank, Capital Small Finance Bank, ESAF Small Finance Bank, Utkarsh Small Finance Bank, Suryoday Small Finance Bank, Fincare Small Finance Bank, North East Small Finance Bank and Shivalik Small Finance Bank.

Besides, many financial entities are currently waiting to get the final nod from RBI to get SFB license.