With low NPAs and better interest rates, how healthy are bank deposits? (2024)

Interest rates are at their peak in the current cycle and are poised to fall as the US Federal Reserve and central banks globally, including the Reserve Bank of India, get set to cut them as they become comfortable with easing inflation numbers.

Aside from debt funds, investors find bank fixed deposits are also attractive at the prevailing high rates. But there have been instances when bank deposits are frozen and withdrawals blocked, even if temporarily – enough to cause shock and panic.

Are banks still unhealthy?

India’s banking sector has improved remarkably since the break-out of non-performing assets (NPAs) from 2016-17. There have been measures such as loan write-offs, recovery drives, and recapitalisation by the government.

For a perspective, the gross NPAs of all scheduled commercial banks reached a record of 11.2 percent in 2017-18, and net NPAs were 6 percent. As per the RBI’s Financial Stability Report released in December 2023, gross NPAs eased to 3.2 percent and net NPAs to 0.8 percent as of September 2023.

Within this, the gross NPA levels of public sector banks were at 4.4 percent, while those of private sector banks were at 2.1 percent. The data clearly shows that the health of the banking sector is improving and indicates a much higher level of safety for depositors.

For any bank, managing NPAs is crucial to maintain financial stability. If NPA levels go out of control, the risk of mismanagement may ultimately be borne by the depositors because the existence of the bank itself becomes a question and people may lose their money.

Public sector banks have the implicit safety of government ownership. In the private sector, there are the leading banks that are well known.

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Not all are the same

Within banks, there are the cooperative banks, which foster financial inclusion by catering to the needs of specific communities or regions, thereby contributing to the nation’s economic development. While the purpose of cooperative banks remains uncontested, their health has been a matter of rising scrutiny, given the extent of NPA issues as well as failures.

A notable case that is still fresh in public memory is that of the . It is not just about one case from five years ago. Quite a few cooperative banks were shut down in 2023-24, which shows there is a higher risk for depositors in such banks compared to other categories of banks.

Such bank failures can arise from factors including ineffectiveness of management, lack of governance, and poor financial vigilance. Since cooperative banks are regulated by the RBI and the respective state governments, there is the matter of dual regulation and this leads to supervision issues.

The RBI implemented certain measures to address the problem. These include enforcement of stricter norms on asset quality, management efficiency and capital adequacy. The aim was to ensure effective and timely resolution of NPAs to prevent further deterioration of the bank’s health. Despite these efforts, the challenges continue to exist.

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As per the RBI, the gross NPAs of urban cooperative banks (UCBs) stood at 10.9 percent in September 2023, an increase from 8.7 percent in March 2023. While other categories of banks improved their health with lower NPA levels, cooperative banks failed to match up.

A stress test conducted by the RBI on 214 major UCBs, covering 68 percent of the assets in the UCB sector, based on their financial position as of September 2023, showed that 43 UCBs would fail in a medium-stress scenario and 57 would fail in a severe stress scenario. Such statistics indicate there is a relatively higher risk of cooperative bank failures, where depositors may suffer.

Though the RBI has increased its oversight and supervisory position over cooperative banks by conducting regular audits, stress tests and building uniform regulatory frameworks to prevent failures and protect the interest of depositors, it is better to be safe than sorry.

In this context, it is important to take note of the Deposit Insurance and Credit Guarantee Corporation, which covers each depositor in a bank – commercial or cooperative – up to Rs 5 lakh. This was revised from Rs 1 lakh in February 2020.

This is in the event of liquidation of the bank. The timeline of the insurance settlement used to be indefinite before, till the case was settled in a court of law. Now, that has been reduced to months.

Conclusion

Public sector banks have the backing of the government, and leading private sector banks have strong fundamental quality – one doesn’t have to think much about insurance cover.

However, for a cooperative bank, insurance becomes that much more important. For fixed-deposit investors, public sector and private sector banks are preferable. Be a bit careful when investing in cooperative banks.