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Park your money well

Here are some personal finance lessons you can draw from the PMC bank crisis

Punjab and Maharashtra Cooperative (PMC) Bank, a bank with more than Rs 11,500 crore of deposits, is in trouble.

The Reserve Bank of India (RBI) has limited deposit withdrawals to Rs 10,000 per account. This obviously has  depositors up in arms. In several videos going around on the social media, the depositors are seen asking, “It’s my money. Why am I not allowed access to it?”

Some depositors have wedding expenses to meet. Some others are dependent on the money in the bank for their regular expenses. In short, there is a problem which the depositors did not create but are facing the repercussions of. In economics, this happens all the time.

Of course, when it comes to cooperative banks, the RBI has been caught napping once again. Given the large number of cooperative banks operating in the country, that is hardly surprising.

But that’s the way things are and a large number of depositors have ended up in a financial mess, for really no fault of theirs. Hence, this crisis is an opportunity for all of us to learn a few basic lessons in personal finance all over again. Let’s take a look at these lessons one by one.

1) The oldest cliché in personal finance is diversification or as financial planners like to spell it out: Don’t put all your eggs in one basket. This applies within and across asset classes. Hence, it is important to spread the money that you want to save in the form of deposits, across bank accounts of different banks. If one bank gets into trouble, you have access to some of your money deposited in other banks.

2) The moment people put money in a bank they just assume that it is safe. It is worth remembering here that banking is also a business at the end of the day. And businesses fail all the time. So, do banks. A bank borrows money at a certain rate of interest and lends it out at a higher rate of interest. If the money that the bank lends out is not repaid then the bank may not be in a position to repay a part of the deposits.

Of course, banks usually don’t default on their deposits because when a bank reaches such a stage, the RBI intervenes and typically merges it with another bank. In the past the New Bank of India was merged with Punjab National Bank. The Global Trust Bank was merged with the Oriental Bank of Commerce. This creates an illusion of safety around banks.

In case of public sector banks, the government keeps reinvesting money in these banks to ensure that they are in a position to continually keep repaying the deposits which are maturing. In the last financial years, the government has invested Rs 2.06 lakh crore in public sector banks to keep them going. It is this money that has ensured that many of the public sector banks haven’t defaulted on their deposits because as a business they are in a complete mess.

Of course, most people continue to be unaware of these things. They deposit their money in a public sector bank and forget about the safety aspects of it totally, with the assumption that the government is going to come to the rescue in case of any trouble. But even with that, is it really worth it?

3) There are many public sector banks which have a bad loan rates of more than 10%. This basically means that out of every Rs 100 of loans these banks have given out, more than Rs 10 hasn’t been repaid for a period of 90 days or more. Some even have a bad loan rate of 20% or more. And people continue to happily bank with these banks.

The question is should you really be banking with these banks? What is it extra that these banks are offering you which another public sector banks (let’s say the State Bank of India) doesn’t? Maybe a 0.5% extra interest? Maybe the clerk(s) at the bank are polite to you? Maybe you have a locker there? Maybe the branch manager is a nice chap? But is it really worth the risk?

When there is a better public sector bank available to deposit your money, why go with a lesser one? I guess lethargy and laziness are the only answers.

This is not to say that the government won’t rescue these banks if they get into more trouble. It will. But what if the RBI restricts access to deposits for a certain period of time, while it sorts out things, like it has done in case of the PMC Bank. What happens then? While safety of deposits is paramount, access to deposits is equally important. At the end of the day, what good is any money, if it cannot be spent when needed?

4) The attitude that just because money is in the bank it is safe, needs to go. All money which is invested carries some sort of risk. A good cutoff to work with is to stay away from banks which have a bad loan rate of 10% or more. In order to check this data out you can go to the website of the bank and search for its investor presentation which is published every three months. (Or you can simply Google).

Also, the assumption that all public sector banks are safe is an unsafe one. Please get rid of this nonsense from your heads as soon as possible. Over and above this, keep track of information around the bank where have deposited your money.

To conclude, people spend more time planning a holiday and figuring out which mobile phone to buy these days than thinking about where to invest their hard-earned money. It is this attitude which costs them ultimately in the end. It is worth remembering at the end of the day that it is your hard-earned money and only you can be dumb about it.

Vivek Kaul is the author of the Easy Money trilogy