Has A Bank Ever Told You Its Deposits are Riskier than Stocks? These Should Have... - The 5 Minute WrapUp by Equitymaster
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Has A Bank Ever Told You Its Deposits are Riskier than Stocks? These Should Have...

Jul 3, 2018

Tanushree Banerjee, Editor, The 5 Minute Wrapup

The value of your fixed deposit in ABC Bank crashed by 95% at today's closing prices.

Has your bank ever sent you such messages?

Do you find the idea ridiculous?

Well, not if you expect your bank to be completely honest with you. And believe that it should worry about its own bankruptcy.

Today, more than half the public sector banks do not have the capital to pay back depositors.

Believe it or not, the losses of these banks are several times the value of the deposits they owe you. And if they must shut down, they could simply not repay depositors. Unless the government makes good their losses and capitalises them.

So, left on their own, they might have to mark down the value of deposits by 90% to 100%.

In that case, your banker would have to tell you about a crash in your fixed deposit value, like your broker tells you about your stocks.

Reminds you of the crash in smallcaps, doesn't it?

The problem is that we think about stocks and fixed deposits very differently.

We take it for granted that stocks are perpetually at high risk, for their returns are not guaranteed.

And the guaranteed return from fixed deposits makes us complacent about their risk, especially if the deposit is in a public sector bank!

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If you remember, I asked this question in an issue of the Wrapup earlier this year.

Are the Stock and Deposits of State Bank of India Equally Risky Today?

The deposits of State Bank of India (SBI) enjoy a sort of sovereign guarantee. So, they are considered the gold standard for a low risk asset in India.

But is that true for every public sector bank? And should you blindly assume that your deposits in them carry no risk?

Well, you won't, if you take a look at this...

Banks on the Verge of Bankruptcy

Public Sector Banks Net NPA to Networth
Allahabad Bank 159%
Indian Overseas Bank 154%
IDBI Bank 135%
Oriental Bank of Commerce 121%
United Bank of India 119%
Andhra Bank 117%
Punjab National Bank 115%
Union Bank 96%
Central Bank 95%
UCO Bank 94%
Corporation Bank 92%
Data source: Companies

11 out of the 21 public sector banks in India have net non performing assets (NPA) higher than or almost equal to their networth. In an ideal case, their depositors would be warned and the entities would be wound up. Offering deposits in the garb of safe assets, in near bankrupt entities, is mis-selling.

If this was the case with a private sector non banking entity, you would have voluntarily given up the idea of getting your deposits back. Or at least tried to redeem them as soon as possible. But these banks - with blessing of the government - manage to keep depositors in the dark.

So when you think of risk, make sure you don't rule out asset classes.

Even the seemingly safest ones could carry a high degree of risk. And even the much-feared ones, like stocks, could, in fact, be a safe haven.

Black Swan author, Nassim Nicholas Taleb says that anyone who survived in the risk-taking business lives by a version of Warren Buffett's sermon 'in order to succeed, you must first survive'.

Taleb's version is...never cross a river if it is, on average, four feet deep.

Mine is...to finish first you must first finish.

Which is why I look for a big margin of safety even in risky asset classes like stocks. And having recommended safe stocks for over a decade, can confidently tell you, that the risk of losing money in them is less than that of deposits of some banks.

So, dispel the myth that bank deposits do not carry risks. Check if your bank is telling you the truth.

If you still aren't convinced, ask yourself if the best stocks (bought at their best valuations) are really as risky as bank deposits, over the long-term. Just look at that NPA data again.

To finish first and to finish your investing journey well, embracing Safe Stocks for the long term, is the way to go.

Chart of the Day

Ask an average Indian investor about the next best thing after safe bank deposits. I can bet they would tell you about LIC policies. For generations Indians have treasured LIC policies in their safe deposit lockers like their gold and fixed deposit receipts.

Life Insurance Corp. of India (LIC) meanwhile, has been acting like the government's ATM for years. It has bailed out public issues of scores of PSUs. And helped the government milk it by buying a majority stake in several state-owned lenders. The latest attempt to bail out the troubled IDBI Bank is a classic case of the state insurer buying toxic assets.

In fact, given the high stakes that LIC owns in the most troubled banks, the government needn't even consider the proposal of setting up a 'Bad Bank'. It could just turn LIC into one. At least then the investors owning investments in LIC policies, would know the real risk they carry.

LIC - The Default Bad Bank?

Warm regards,

Tanushree Banerjee
Tanushree Banerjee (Research Analyst)
Editor, The 5 Minute WrapUp

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5 Responses to "Has A Bank Ever Told You Its Deposits are Riskier than Stocks? These Should Have..."

Premakumar.j

Jul 7, 2018

Highly informative

Like 

paul wilson

Jul 7, 2018

The bail in provisions which you highlighted here are the natural sequences being pursued in terms of Basel III banking and financial reforms and being pressed through G20 summit. In fact, Cyprus and Turkey experienced the bail in provisions when depositors with more than Euro 100000 had to forego abt 30% of their deposits. This is a little difficult in Indian circumstances. Till date no bank was allowed to fail and this bail in procedure will not be easily digested here in India. However, the FRDI bill provides for it and its an anticipatory bail for such harsh steps when a financial resolution becomes necessary. The role of RBI as a lender of the last resort is also done away with in the FRDI bill.

Like (1)

paul wilson

Jul 7, 2018

The statement that the deposits with SBI enjoy special sovereign status is absolutely wrong.Till date we have the DICGCI coverage upto Rs.One lac and the same applies to SBI as well. Shortly the FRDI bill will replace these provisions. However, the coverage limit will continue. There was even a provision that SBI cannot be liquidated.The new FRDI bill overrules this as well.The deposits are equally placed in terms of risk with all the commercial banks in India.

Like (1)

Rajiv

Jul 5, 2018

Are customer deposits (in commercial banks in India) treated at par with senior secured debts of banks or unsecured debts? Is there any difference between current account , savings account and fixed deposits?

If not, what's the seniority of customer deposits in the hierarchy of commercial retail bank's liabilities?

For this, please ignore deposit insurance (which at 1 L is paltry anyways).

Any links to case studies wherein a bank went bankrupt would be helpful.

Like (2)

RK JHA

Jul 3, 2018

This mailer was an eyeopener . Would have been better if suggestion for better investment avenues apart from stock investing would have been suggested by my preferred editor- as I have faith in her views thus far - and it is NOT going to waiver.

Like (2)
  
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