Invest with care in small finance banks as they also cut rates

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The days of small finance banks offering over 7% returns on fixed deposits (FDs) are coming to an end. Most have started reducing interest rates across segments.

Suryoday Small Finance Bank is the latest to lower deposit rates. From 21 June, the bank will reduce FD rates by 25-100 basis points on different maturities. One basis point is one-hundredth of a percentage point.

The steepest reduction is on five-year FD, which it will offer at 6.25% compared with 7.25% earlier. The lowest cut (25 bps) is on FDs between one and two years, at 6.5% compared with 6.75% earlier.

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In the first week of June, Capital Small Finance Bank and Equitas Small Finance Bank, too, had reduced their interest rates. Capital Small Finance Bank offers the highest interest rate on a 900-day FD at 6.25%, and Equitas Small Finance Bank offers its highest rate, 6.5%, on an FD of 888 days. Fincare Small Finance Bank and Jana Small Finance Bank had lowered interest rates last month.

The only banks that offer a 7% interest rate on FD are Utkarsh Small Finance Bank (for 700 days) and North East Small Finance Bank (for 777 days), according to their websites.

Most of these banks are still attractive if a depositor wants to open an FD for a short term. They offer between 6% and 6.5% rates for maturities of over one year and up to three years.

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The Reserve Bank of India had started offering small finance bank licences only around six years ago. Some microfinance institutions opted for small bank finance licences. As these companies are yet to establish a track record as banks, most investment advisers recommend depositors should park only short-term funds with them.

“Many of these banks lend to a population that would be considered ‘risky’ in banking. We are yet to see how covid-19 impacted these borrowers. Therefore, I would advise depositors to be cautious,” said Basavaraj Tonagatti, a Bengaluru-based Sebi-registered investment adviser.

For small depositors, it may be challenging to evaluate a bank’s financials to understand the impact of the pandemic on their depositors. So, look at depositing only limited funds with a small finance bank.

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“Depositors can book an FD of up to three years. However, they should restrict investments up to 5 lakh,” said Mrin Agarwal, founder-director, Finsafe India. She suggests the cap as deposits of up to 5 lakh are insured under the Deposit Insurance and Credit Guarantee Corporation.

For longer tenures, Agarwal suggested post office time deposits, which offer a 5.5% interest rate for one-, two-, and three-year FDs, and 6.7% on a five-year one.

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