Understanding risks linked with banking

Risk is absolutely fundamental to investing but an investor needs to figure out where risk really lies and what is the difference between low risk and high risk, reports Tehelka Bureau

The Central Board of Reserve Bank of India’s (RBI) will be meeting on December 13 in Odisha’s capital Bhubaneswar. The agenda is to ask the Deposit Insurance and Credit Guarantee Corporation (DICGC), the wholly owned subsidiary of the RBI to establish a separate reserve to safeguard the interests of depositors of banks.

The move comes on the heels of the Finance Ministry move to increase the deposit insurance limit to 5 lakh from the current 1 lakh. If this hike comes into effect, it will be the first upward revision in deposit insurance. The last revision in the current limit of deposit insurance was effected on May 1, 1993, after the Bank of Karad collapsed in the securities scam of 1992. The move is coming in the aftermath of scams just as in the case of the Punjab & Maharashtra Co-operative Bank (PMC Bank) and the Pen Co-operative Urban Bank.

No risk free banking

The developments lay focus on the fact that there is no such thing as risk-free banking. At times you avoid non-banking finance companies thinking that deposits in the NBFCs are not safe. Is your money safe with banks? Think again. The money you consider safely deposited in your banks, whether public sector or new generation banks too is subject to various risks and not hundred per cent safe.

There is nothing called as risk-free banking. I am not talking about online frauds of fraudulent transfer of funds.  Let us understand the basic safety nets in place that can save you from total loss in case your bank goes bust. The Deposit Insurance And Credit Guarantee Corporation (DICGC) insures all bank deposits up to 1 lakh. Means even if you have 1 crore lying in your bank or more, the Deposit Insurance and Cred Guarantee Corporation insure just 1 lakh. God save the rest.

And mind it, all your savings, fixed deposits and recurring deposits, at the same bank across any number of branches are insured up to 1 lakh. God forbid if there is a problem with your bank and it goes bust, the DICGC will compensate you to this limit of just 1 lakh. You may not be able to get back rest of your money deposited with the banks beyond 1 lakh. All high-value depositors, salaried persons and pensioners who survive on monthly interest income have nothing to rely upon.  You will be left with just 1 lakh of all your hard earned money lying in your account with any bank if bank goes bankrupt or insolvent.

Observe caution

Well if you are a high value customer of the bank, it is imperative for you to remain alert all the time. As banks say know your customer, you too should know your bank well. You must always be aware as to how your bank is performing. Stability and financial health of your bank is very important to you if you want to safeguard your interests.

You must know how big is the NPA of your bank both gross and net. Non Performing Assets are a good indicator to know about the future of your bank.

You may not know quarterly results of your bank but keep at tab on the year on year performance of your bank. You should also keep an eye if there have been big corporate frauds concerning or related to your bank. In the meanwhile, in a relief for crores of depositors, Finance Minister Nirmala Sitharaman has confirmed that the government would bring legislations on raising insurance cover on bank deposits from the current 1 lakh in the wake of fraud in PMC Bank. The bank has over 11,000 crore in deposits from its customers across 137 branches.

The government would also introduce legislation to regulate multi-state cooperative banks during the Winter Session of Parliament that is on now, the finance minister said. “Work is on and we shall go to the Cabinet for approval to introduce a legislation in winter session. The legislation will amend the necessary Acts and the laws to make sure that banking functions undertaken by cooperatives sector will be brought under the Banking Regulation Act for complying with prudential norms,” she said. Unless the prudential norms are applied, many of the things that are emerging in the light of the Punjab and Maharashtra Cooperative Bank crisis will never be addressed and this legislation will ensure that no PMC like case happens in the future, she said.

Not all eggs in one basket

Never put all your eggs in one basket.  Of late you have been trying to consolidate and have just one account to have better control of your spread. Mind it, it limits your safety and insurance spread. As such all-high value customers and other depositors who have more than a lakh as deposit should invariably more than one account in different banks. Try to diversify your investment and keep many options open. Your money is at more risk in smaller banks and other financial institutions. Instead of putting all your in saving bank deposits or FDs in a bank, invest in mutual funds, equities and other investment possibilities. That will provide you regular returns sans long-term capital gains. You may also explore investing in government securities and post office schemes.

High interest, higher risks

Risk is absolutely fundamental to investing. But as an investor, you have to figure out just where risk really lies and what the differences are between low risk and high risk. There are various reasons why people bank with NBFCs, cooperatives and small banks in their proximity-it could be close to ones place of residence or work or interest rates on deposits may be higher. Human greed is the factor on which unscrupulous elements function and so do some small banks. However, higher risks may be attached to a higher interest rate. 

As the RBI says that when someone is offering you more interest rate than the prevailing market rates, you should view it with a pinch of salt. While banking with someone offering interest rates higher than larger banks, examine your risks. If you’re buying deposits from corporates and NBFCs, pay attention to the credit rating of the company.  Institutions are there to make profit and not working for charity. 

Avoid companies that do not have an “A” rating because of the higher risks of delays in repayment or default. As such, don’t put more money into a higher-risk option than you can afford losing. This also requires an examination of one’s risk appetite at every life stage. Don’t trust the friendly employee or associate of an NBFC or bank. It could be a marketing trick. Understanding the various risks associated with banking and investing is essential to financial stability. It’s your money after all, and you need to be careful about whom you entrust it with. It is your money and you have to be alert about it.