While Bank FDs (Fixed Deposits) are a preferred choice of investment for a majority of Indians, most people don’t know or have never invested in a corporate FD. One might ask why does one need to know about corporate FDs and the answer is to increase one’s return if bank FDs are the preferred mode of investment. So let’s explore the various facets of corporate FDs and how do they compare against the bank FDs
How do Corporate FDs work?
FD is a fixed maturity instrument in which people can invest their savings and can get a predetermined interest. Now generally these FDs are being opened in banks and banks provide interest against these deposits. What happens to this money? Banks forward this amount as loans to individuals and corporates that require capital at a higher interest.
Now if corporates can borrow directly from the general public who has saved money, the intermediary (bank) can be eliminated and therefore the margin which bank takes can be shared between the lender and the borrower.
Contrary to what some may think that the returns in corporate FDs might also be linked to the company’s performance, the returns in corporate FDs are also fixed as in the case of bank FDs. The returns are decided at the start and thus the maturity amount is also fixed.
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Benefits of Corporate FDs
Generally, the biggest benefit as mentioned above is that the interest in corporate FDs is higher than bank FDs. These are generally higher by about 1.5% for high rated bonds and can go even higher for lower-rated bonds.
There is generally a higher interest payout for senior citizens which is similar to fixed deposits in banks. Hence, for senior citizens also the difference is maintained.
Lower penalty period for early withdrawal
RBI has given guidelines that all fixed deposits should have at least 3 months of the penalty period. However, it is observed that generally banks levy penalty on breaking the FD anytime before the maturity. However, this might not be the case of Corporate FDs where you can choose the scheme where you have a lower penalty period.
Hence corporate FDs provide higher flexibility for subscribers where they can withdraw the money even before the maturity date without penalty.
However, this might not be the case with every issuer. For some issuers the flexibility might be reversed and the corporate FDs might be less flexible than banks FDs. Hence, this maybe company specific and should be chosen as per requirement.
Risk associated with corporate FDs
There is a risk of default in any investment – this is called credit risk. In the case of corporate FDs also, this risk is present. Actually, if you see the recent cases of some banks which landed in trouble because of bad loans, you will realize that there is credit risk associated with keeping money with banks also.
However, there is a very important difference between corporate and bank FDs. Bank FDs (including other deposits with the bank) are covered by Deposit Insurance and Credit Guarantee Corporation (DICGC) which is a wholly-owned subsidiary of the Reserve Bank of India. With effect from 4th Feb 2020, the insurance cover which was ₹1 Lakhs has now been increased to ₹5 Lakhs. Some of the important features of this insurance are:
- Insurance kicks in only if the bank closes, if it is still operational /going concern then the insurance does not kick in
- Premium is not borne by the deposit holders our of their quoted interest, it is given by the banks
- All the deposits – savings, current, FDs, etc are clubbed for an individual.
- Deposits across branches are clubbed
- Deposits across banks are not clubbed – hence it might be a good idea to keep savings across banks if credit risk is a huge concern.
The deposits in Corporate FDs are not protected under this scheme. Hence, this lack of insurance makes this a higher credit risk product. The credit risk is higher also because generally banks (reputed) would be more stable than an individual company.
Post-CoVid more thought has to be put in before investing in the corporate FDs because there might be pressure on the balance sheets of the companies. Hence it is advised to go for only some of the AAA-rated safe options.
RBI is always working to protect the interest of investors. Hence, it has set stringent regulations and guidelines for NBFCs and companies which can accept deposits. While there are thousands of NBFCs that are registered in India, only some of them which satisfy the guidelines can accept deposits. Some of these regulations deal with:
- Tenure of fixed deposits – minimum 1 year
- Minimum credit rating – BBB
- Interest rates cannot be more than prescribed by RBI. Also companies cannot offer extra gifts or benefits – to protect from ponzi type schemes
- Total deposits which different companies can take is also regulated
- All relevant information has to be disclosed to RBI
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Tax Treatment of Corporate FD
Tax treatment of corporate FD is at par with bank FDs, i.e. the entire interest is taxed as per the individual’s slab rates and that too with TDS provisions. So for affluent individuals (with the marginal tax rate of 20% or 30%) looking to invest for more than a year, this might become a little worse off option compared to corporate bonds which get taxed at a long-term capital gain rate of 10%.
Another thing favoring the bonds is that bonds are often secured while corporate FDs are unsecured. However, if the investment horizon is less than a year and FDs are providing better yields than bonds of the same company then the investors may choose the corporate FD option.
FDs are not a preferred investment choice for long term horizon. For long term horizon and when investor can assume some risk, it might be better to think equity investments. If however this is not the case then, FDs might the the way to go.
FDs might also be a choice when you want to keep some money in semi liquid form – while there might be some penalty if liquidated, however there won’t be a risk that you might have to sell security at a downturn and loose capital.
In such a case, it might be a good strategy to compare the interest rates for bank and corporate FDs and if you can get a good rated company’s FD at a higher interest payout then it might be the way to go.
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