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Small finance banks offer higher FD rates than commercial banks. Should you invest?

Shaikh Zoaib Saleem
With fixed deposit rates from small finance banks more attractive, how do you take a decision on where to deposit your money? Let’s take a look at a few important parameters.

Bank fixed deposits are among the most popular investment choices among retail investors, particularly because of the guaranteed returns. The first thing a retail depositor notices is the interest rate being offered on a fixed deposit.

Over the past couple of years, small finance banks have started and expanded operations in the country, and their promotional literature and advertisements make it a point to highlight the high deposit rates they offer.

This might be an appealing proposition to a retail investor. For instance, Jana Small Finance Bank is offering a rate of 9% on its fixed deposits of 3 years, and 8.50% for deposits for a 3-to-5-year tenure. The bank is giving 60 basis points more interest to senior citizens. One basis point is one-hundredth of a percentage point.

On the other hand, State Bank of India is offering a rate of 6.8% for deposits between tenures of 3 and 5 years and a rate of 6.85% for deposits over 5 years. Senior citizens get a 50 bps higher rate. “These banks have just started operations and it is not very uncommon for new banks to offer higher deposit rates and play the interest rate card to garner the retail franchise,” said Anil Gupta, vice-president, sector head - financial sector ratings, ICRA Ltd.

With rates from small finance banks more attractive, how do you take a decision on where to deposit your money? Let's take a look at a few important parameters. 

Small finance banks 

Like other commercial banks, small finance banks are also regulated by the Reserve Bank of India (RBI). The main purpose behind having separate small finance banks is to expand access to financial services to unbanked and underbanked sections of the society like migrant labourers, low-income households, small businesses and other unorganised sector entities. They have a mandate to have a higher proportion of their lending to priority sectors.

For a retail consumer, these banks can do almost everything that a normal commercial bank can, including offering basic banking services, accepting deposits and lending. 

Some of these small finance banks are offering a higher deposit rate in order to expand their customer base as well as to gather deposits. Like any other bank, these banks too use the money from the deposits that they gather to lend money to their borrowers.

Should you invest?

While choosing any investment product, make sure you look not just at the returns, but also at the customer service of the financial institution. For instance, having a branch of the bank nearby might be helpful, even though most banking services, including opening a fixed deposit, are now offered online. 

Like any other commercial bank, deposit of up to ₹1 lakh is insured by the Deposit Insurance and Credit Guarantee Corp. (DICGC), a subsidiary of RBI. DICGC has a list of insured banks on its website, and as of 7 January, seven of the 10 small finance banks are listed on its website. 

Ideally, you should take only limited exposure to fixed deposits from small finance banks. This is mainly because these banks have been in operation only for a short time, and analysts say their credit practices as banks may take some time to evolve and strengthen.

“We need to be careful and aware about the fact that some of these entities may not have a too long track record of operations. Hence, one should diversify and not put too much (money) into their deposits. When we talk of risks, up to ₹1 lakh is insured similar to other banks and hence depositors should diversify their deposits across banks,” said Gupta.

However, it is also important to note that many of these small finance banks were micro-finance institutions earlier. But the major difference is that as a bank, they are now allowed to gather deposits. That is unlike a legacy bank, public or private sector, that has many years of track record in handling deposits as well as loans.

“The credit rating practices and mechanism of small finance banks might not be at the same level as that of an older public or private sector bank. So, I would be circumspect about these new age small banks as compared to the older banks, and hence would classify them as somewhat risky,” said Suresh Sadagopan, a certified financial planner and founder, Ladder7 Financial Advisories.

Accordingly, though there might not be an outright risk to your deposits, it is a good idea to diversify and invest only a part of your savings in small finance banks' deposits.