With Higher Interest Rates, Corporate FDs May Seem Attractive, But Know This Before Investing
Corporate fixed deposits (FDs), also referred to as company fixed deposits, are investments where funds are deposited for a predetermined period at a fixed rate of interest. These deposits are offered by financial institutions, including non-banking financial companies (NBFCs). The maturity period of corporate FDs typically varies from several months to several years. Similar to banks, the Reserve Bank of India (RBI) authorises certain NBFCs to accept deposits at fixed rates and terms. These deposits are commonly known as company or corporate FDs in everyday language.
Difference Between Corporate FDs And Bank FDs:
The primary distinction between corporate FDs and bank FDs lies in the deposit rate that is offered. Corporate FDs typically offer a higher rate of interest compared to bank FDs, as they must compete with banks for depositors’ funds. The interest rate associated with corporate FDs is contingent upon various factors, including the issuer’s credit rating, deposit duration, deposit amount, and the prevailing market conditions.
Another disparity is the security of the deposit. Bank FDs are backed by insurance from the Deposit Insurance and Credit Guarantee Corporation (DICGC) for up to Rs 5 lakh per depositor per bank. This implies that in the event of a bank’s failure, depositors’ funds are secure up to Rs 5 lakh from DICGC. Conversely, corporate FDs lack insurance coverage from any agency, thus posing a heightened risk of default by the issuer. Consequently, it’s crucial to assess the credit rating of the corporate FD before investing.
Another differentiating factor concerns the taxation of interest income. For both bank FDs and corporate FDs, tax deducted at source (TDS) is applicable at a rate of 10 per cent when the interest income surpasses Rs 40,000 in a financial year (Rs 50,000 for senior citizens). However, bank FDs offer the additional option of submitting Form 15G or 15H to circumvent TDS if one’s total income falls below the taxable threshold. In contrast, corporate FDs lack this provision, resulting in TDS deductions regardless of the individual's income level.
Are Corporate FDs Attractive?
According to Abhishek Kumar, a Securities And Exchange Board Of India (Sebi) registered investment advisor, and founder, and Chief Investment Advisor of SahajMoney, a financial planning firm, one should not just get swayed by higher rate of interest offered by corporate FDs.
“The credit rating of the corporate is an important factor to consider before investing in such investment instrument. As these corporates are competing with banks to garner deposits from the public, hence they generally offer higher interest rates than banks. So before investing in these FDs, one is advised to do their due diligence,” says Kumar.
He adds: DICGC safeguards bank fixed deposits up to Rs 5 lakh, whereas corporate FDs are not covered. Consequently, in cases of defaults, corporate FDs are affected.”
According to Amar Ranu, head – investment products & insights, Anand Rathi Shares and Stock Brokers, corporate FDs are purely bought on basis the credit creditworthiness, company track record, etc.
“Post removal of tax arbitrage from debt MFs relative to any other debt instruments including corporate FDs, it makes sense to allocate up to 20-30 per cent of the debt portfolio to corporate FDs. Mostly, financial organisations, such as non-banking financial companies (NBFCs) and others provide corporate FDs,” adds Ranu.
He says that prior to investing a corporate FD, investors should research the credit rating of these corporate FDs to assess the credibility of the institution. A higher AAA rating signifies a reduced probability of defaults on interest and principal repayments, he adds.
“Before investing, one should be mindful of creditworthiness, liquidity, security (insurance), interest rate, parent back up, and liquidity,” adds Ranu.
Keep In Mind
According to experts, conservative investors should steer clear of corporate FDs due to the higher risk involved. Only those with moderate to aggressive risk tolerance levels should consider investing in them, but they must thoroughly understand the risks beforehand.