Small Finance Banks Lure With 9% Interest Rates On FDs, Should You Invest?

Since May last year, the Reserve Bank of India (RBI) has raised its repo rate six times, or an aggregate of 250 basis points. While this has made home loans more expensive as their interest rates have gone up, fixed deposit (FD) rates have also increased.

For example, SBI is offering interest rates of 7.5 per cent for term deposits of two to three years or five to ten years. However, small finance banks are offering even higher interest rates. For senior citizens, interest rates on fixed deposits can be as high as 8.5 per cent to nine per cent.

Since FDs provide guaranteed returns, they have always been popular with investors. With the high-interest rates offered by small finance banks, investors would like to invest their money into FDs. But since small finance banks are considered riskier than scheduled commercial banks. The question is whether one should invest in such FDs.

Are They Safe?

It is safe to have FDs of up to Rs 5 lakh with different small finance banks.

The RBI directly regulates small finance banks since they have been categorized as scheduled banks, just like PSUs and other private sector banks.

"Deposits opened with scheduled banks are protected by the deposit insurance program of DICGC. Having cumulative deposits (including fixed deposits) of up to Rs 5 lakh with each of these small finance banks is as safe as depositing money with PSU and large private sector banks. Note that the upper limit of Rs 5 lakh includes principal and the accrued interest," says Adhil Shetty, CEO, BankBazaar.com.

While investing, one must remember that returns are always linked with the risk associated with the investment. With higher returns come higher risks.

Says Chenthil Iyer, founder and chief strategist, Horus Financial Consultants, "If you want to invest more than Rs 5 lakh, either invest on a different person's name. or choose a different small finance bank."

He says that small finance banks lend to those people who generally may not get loans from big banks. However, they charge higher interest on their loans, allowing them to provide higher rates to depositors. The only catch is that since the quality of borrowers could be subprime, the default ratio may also be higher. The silver lining is that their average loan ticket size may also be smaller, making the impact of a default lesser.

Plan Your FDs Wisely

One needs to be careful about the quantum of investment in these banks. If you are still working and have prepared your investment strategy, you may invest the debt component of your asset allocation into these FDs.

"However, never put your liquidity reserve money in these FDs as you would need to break them at short notice and hence better to put that with a recognized large bank. If you are a senior citizen, you must first exhaust the Senior Citizens' saving schemes limit with a sovereign or government guarantee before you entrust your money with these banks," says Iyer.

These days the limit for Senior Citizens' Saving scheme offered by the post office has been increased to Rs 30 lakh per person with an attractive interest rate of 8.2 per cent! "One should utilize that first and take a half-yearly interest payout from it, then parking it with small finance banks and take mental stress for a reward of just 0.5 per cent to 1 per cent more interest," says Iyer