How safe is your money in the bank and what can you do about it?

Karan Deo Sharma
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How safe is your money in the bank and what can you do about it?

How safe is your money in the bank and what can you do about it?

Safety of money in bank deposits is now a prime concern for many account holders after three bank failures in the last one year, starting with Punjab & Maharashtra Bank (PMC) bank in September 2019. The latest to join the Reserve Bank of India’s list of banks under moratorium is the Lakshmi Vilas Bank (LVB). Simply put, account holders of LVB cannot withdraw more than Rs 25,000 in the next one month. In the meantime, RBI is working on LVB’s merger with the Indian subsidiary of Singapore’s DBS Bank.

After the PMC Bank, a moratorium was imposed on Yes Bank in early March this year. While Yes Bank is back on its feet and is functioning normally after a rescue led by the State Bank of India, PMC remains under moratorium. Under the current RBI diktat, PMC depositors are only allowed to withdraw Rs 1 lakh per customer.

While in theory bank deposits and interest of up to Rs 5 lakh per depositor are insured, repeated bank failures and RBI moratorium on withdrawals puts savers in a bind. 

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What’s the use of a hefty deposit if you can’t access it even if the barrier is just for a month or two? In our minds, bank deposits are as good as cash or at best a day away from our pockets.

The recent development in the banking sector forces us to reassess the long-held beliefs about banks deposits and its place in our financial planning.

To answer the initial questions, most bank deposits are not in danger and depositors can sleep easy at night. But as a matter of principle, bank deposits are not 100 percent safe either. 

The risk to depositors rises longer the economy and India’s industrial sector remains under slowdown.

Banks, whether small or big, are at the heart of the economy and almost every transaction passes through the banking system at one point or the other. Banks are financial intermediaries and make money by lending depositor’s money to businesses and individuals. This puts banks at risk when economic downturn leads to failure of firms and job losses.

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When recession hits economic activity and demand for goods and services falls, many borrowers fail to repay their loans and banks are forced to book losses.

If the amount of these bad loans becomes too large it leads to a situation where a bank may run out of cash to pay depositors when they come to withdraw their money.

This is what happened with all the three troubled banks. They piled-up large amounts of bad loans as the economy remained in the slow lane.

As a depositor, we don’t have any control over the banks’ lending policy and its bad loans. But surely, we can follow this checklist while entrusting the bank with our hard-earned money.

1.       As always in life, don’t put all your eggs in one basket. Spread your savings, especially if it’s a large sum, over 4 to 5 different banks and the list must include at least two public sector or government-owned banks. Never mind if government-owned banks pay lower interest than many small private sector or co-operative banks. Capital preservation should be the number one priority for any saver and investor in the current economic environment.

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2.       Banks don’t fail in a single day. A bank's financial position deteriorates over a period of time and if you pay attention to the news flow, especially the business and the economic developments, you will have enough time to pre-empt a bank's eventual failure. So as soon as the business news flashes a red signal or your bank reports a big loss or gets a rap from the regulator, start drawing down your deposit from the bank.

3.       Keep a watch on a banks’ credit ratings. Banks are under constant scrutiny of rating agencies such as Crisil, CARE Ratings, ICRA or India Ratings. Keep a watch on the rating downgrades. If a bank gets a sudden downgrade from rating agencies it's time you reevaluate your deposit with the bank. For example, rating agencies were repeatedly downgrading Yes Bank all through 2019 due to the bank's failure to raise capital to bolster its balance sheet.

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4.       A sharp decline in share price is a sure sign of a banks’ financial trouble. For example, Yes Bank share price declined by three-fourth between March and September 2019. Similarly, Lakshmi Vilas Bank share lost 90 per cent of its value between June 2017 and October 2019 that sealed its fate. An extremely low market capitalisation relative to its balance sheet makes a bank technically insolvent as it cannot raise fresh capital to bolster its financial position or discharge its liabilities. So, there were enough warning signs as well as time for Yes Bank and LVB customers to take control of their deposits before they were put under moratorium.

However, I must add that PMC Bank provided few warning signs to its depositors other than that interest on its deposits were among the highest in the industry.  PMC was neither listed nor was it rated by the rating agencies. Here diversification and a questioning of its considerably higher deposits rates may have lessened the financial blow for many of its depositors.

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5.       Lastly, diversify your savings options and treat bank deposits as one of the many vehicles to park your savings. Besides banks deposits invest in post office deposits, bond funds and large cap equity and last but not the least gold. In fact, gold has the least counterparty risk and it is the ultimate liquid asset in a scenario when most other assets may fall together in case of any economic crisis. If possible, also invest in cash-generating physical assets such as commercial or residential real estate.  

In all, trust your bank only within limits and diversify your investments.

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

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