Are Fixed Deposits Really Safe?

Fixed Deposits (FDs) have been around for a while and have always been a dependable investment option for most. With the FD rates at their 7-year high and the equity market in the red, they seem more lucrative than ever. Small finance banks offer higher FD rates than other banking institutions to attract investors.

With the increasing number of bank failures worldwide, one might be concerned about their deposits. It is natural to wonder if their money in the bank is safe when we hear of reliable banks going under.

Why the higher interest?

Small finance banks (SFBs) are riskier than traditional commercial banks because despite having the same governing body, the Reserve Bank of India (RBI), they carry different levels of risk. The RBI does not insure FDs held with SFBs - deposits up to Rs 5 lakhs are insured by the DICGC instead. Meanwhile, FDs in commercial banks up to Rs 5 lakh are insured by the RBI.

These small finance banks usually carry significant credit risks as their portfolio consists of microloans that are usually unsecured, and their credit ratings are unstable.

Key ratios to watch out for

Several ratios are readily available to study the financial health of your bank.?

Capital Adequacy Ratio: measures a bank’s ability to meet its obligations and determines the risk of bank failure. The RBI sets a minimum CAR level to prevent banks from taking excess leverage and becoming insolvent, ensuring the bank can absorb a reasonable amount of loss. Private banks usually have a 9% CAR requirement, public sector banks maintain 12%, and small finance banks must have a CAR of 15%.?

Net Stable Funding Ratio: This ratio ensures that the bank uses more stable sources of funds to raise money. It is computed by dividing the stable funds available by what the bank needs. The higher the ratio, the safer the bank.?

Liquidity Coverage Ratio: This measures the ability of the bank to survive short-term stress scenarios. It checks to see if the bank has enough high-quality liquid assets to cover its drawings for 30 days.?

?Current Account to Savings Account Ratio: measures the share of current and savings deposits in the total capital. They are relatively cheaper sources of funds as banks pay low or no interest on these deposits.

Gross Non-Performing Assets: Banks often have bad loans that are doubtful or defaulted payments for at least 90 days. A high GNPA may suggest poor lending standards and practices.?

Leverage Ratio: measures the amount the bank has lent its customers compared to its actual asset pool. A higher leverage ratio suggests that a bank has utilized its funds properly.

Qualitative measures

The bank should have a well-diversified consumer base as it ensures that its loans are not concentrated in an industry or region which increases risk. The bank should also be transparent about its performance with regular updates that project its numbers. A delay in reporting or lack of comment during a crisis might suggest a problem.

Are your FDs safe?

As one can see from the table above SFBs and commercial banks both maintain healthy ratios. However, SFBs usually have higher NPAs that suggest higher credit risks.?

Before you put your hard earned money in smaller banks to earn higher returns, it is wise to keep a tab on some of these metrics and monitor the performance of banks. One should also stay vigilant of the news and trends in the bank's credit rating and performance, as these ratios alone do not suffice.?