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Bank investments and risks

Updated: Sep 22, 2020

Tradition in our culture often seems to equate economic comfort with having money in the bank. Even western literature mentions banking one’s wealth. It is considered an essential query for a man evaluating a prospective son-in-law to ask if he has a bank balance, which translates to checking if he has the ability to take reasonable care of his precious daughter.

Having money deposited in the bank gives a person plenty of comforts, though normally his financial advisor who will talk of the poor returns and taxability of the interest making bank deposits a tax-inefficient investment, earning negative real returns. (Real returns are inflation-adjusted returns, or post inflation returns).

A tradition that follows the comfort of money in the bank is to panic at the hint of a bank failure and lining up to withdraw money, usually at the precise time that the bank is hard-pressed to arrange liquidity to return money to the depositor. Besides the risks of loans given by banks to businesses unfortunately caught in a bad spot going bad, or loans given recklessly there are “maturity mismatches” that can catch a bank with its pants down. These are common asset-liability mismatches that are tracked by a high-powered ALCO (Asset-Liability Management Committee). Most deposits that a bank gets are of a short-term nature of up to a year. Loans have a longer tenure (home loans are for an average of 15 years and may extend to 30 years) which makes even very sound banks jittery at times (one possible reason for many senior banker’s heads being a tad bald).

Depositors have a certain amount of comfort, even having invested in rather risky banks – deposit insurance! Deposit insurance started in the USA in 1934 at the 2nd dip of the Great Depression that started in 1929. The rest of the world turned a blind eye till India was kicked awake in 1962 with the failure of Laxmi Bank and Palai Central Bank. India became the second country in the world to guarantee bank deposits when the Reserve Bank of India provided a deposit guarantee till it formed the Deposit Insurance and Credit Guarantee Corporation (DICGC) in 1978, with a Deputy Governor of the RBI as the Chairperson. Under the terms, every depositor is provided Rs. 5 lakhs guarantee (increased from Rs. 1 lakhs this financial year 2019-20). This guarantee is for Rs. 5 lakhs per BANK (NOT account), free to the customer as the insurance premium is paid to DICGC by the bank. DICGC is authorized to cancel the registration of a bank defaulting on premium payment.

There are ways to squeeze higher returns from a bank than by investing in fixed deposits. We will visit these options and understand the risks involved in our next segment. The suitability of the non-fixed deposit products and the associated risks are especially relevant in the light of the Reserve Bank extinguishing the AT1 Bonds of Yes Bank, costing substantial losses to investors in such bonds.

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