Diversification and Concentration: Assessing the Risks of Concentrating Deposits in a Single Institution

Financial Report: Diversification of Bank Deposits

Key Takeaways

• In India, deposits are insured up to Rs 5 lakh per depositor per bank under the Deposit Insurance and Credit Guarantee Corporation.
• Concentrating deposits in one bank exposes you to access risk, which is more common than bank failure.
• Splitting deposits across two banks doubles insured cover to Rs 10 lakh, while three banks increase it further.

Banking Risk

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Total bank failure is rare in large scheduled banks, but operational disruptions can temporarily freeze accounts. This can lead to immediate financial stress if multiple transactions, such as rent, school fees, and credit card auto-debits, depend on a single bank.

Benefits of Diversification

• Increases insured coverage
• Reduces liquidity stress in case of unexpected events
• Provides more control over finances
• Does not require sacrificing relationship benefits, such as preferential loan processing or better fixed deposit rates

Structuring Deposits

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• Assign roles to each bank: primary bank for salary and monthly transactions, secondary bank for emergency fund and fixed deposits
• Keep business flows separate if running a business
• This structure also helps prevent impulsive use of emergency funds

Large Public Sector and Private Banks

Systemically important banks are less likely to collapse, but the insurance limit still applies. Diversification reduces tail risk and is a low-cost strategy.

Conclusion

Concentrating all savings in one bank is convenient but not strategic. Splitting funds across at least two banks is a simple and effective way to increase insured coverage, reduce liquidity stress, and gain more control over finances.