Corporate Fixed Deposits
What are corporate FDs?
Bank fixed deposits has traditionally been and still is the most popular investment option in India. As per RBI's report on household savings, 56% of household financial assets are invested in Bank FDs. Corporate Fixed Deposits are term deposits like bank FDs. They offer fixed rate of interest and principal amount on maturity. However, instead of banks, corporate FDs are offered by non banking financial companies (NBFCs). Corporate FDs are very popular among informed investors since offer higher returns compared to bank FDs.
Bank FD versus Corporate FD
Rate of return : Interest rates of corporate FDs are usually higher than interest rates of banks FDs. For example current 3 - 5 year FD interest in SBI is 6.1%, whereas Bajaj Finance is offering 7% interest rate on 3 - 4 year FD. Interest rates of corporate FDs vary from one company to another depending on the credit rating of the company. We will discuss about credit ratings later.
Tenure : The tenure for bank FDs range from 7 days to 10 years. The tenure for corporate FDs range from 12 months to maximum 4 - 6 years. If you want to invest for very long tenure e.g. 8 to 10 years, then bank FD will be the only term deposit option for you. However, for shorter tenures you may consider corporate FDs.
Lock-in period : There is no lock-in period in bank FDs. Corporate FDs may have lock-in period. Usually lock-in period for corporate FDs is 3 months; you cannot make any withdrawal prior to the completion of the lock-in period. However, not all corporate FDs may have lock-in periods.
Premature withdrawals : Premature withdrawals are allowed in both bank and corporate FDs. However, penalties may apply for premature withdrawals may be applicable for both bank and corporate FDs. If you want the flexibility of making premature withdrawals, then bank FDs will be the more favourable option for two reasons (a) no lock-in period (higher liquidity) and (b) lesser premature withdrawal penalty. While bank FDs may offer more flexibility for premature withdrawals, you should weigh this as a trade-off against higher returns offered by corporate FDs.
Risk : Banks are regulated by RBI, who ensures that banks have sufficient capital adequacy to cover their financial liabilities (e.g. savings bank, term deposits). Furthermore, RBI covers security up to 1 Lakh rupees on fixed deposits. So bank FDs have very low risk. However, in extreme cases we have seen restrictions on premature withdrawals; these cases are very rare though. Risk in corporate FDs depends on the credit rating of the corporate FD. Credit rating agencies like CRISIL, ICRA etc, assign credit ratings to corporate FDs depending on the financial strength of the NBFCs. The highest credit rating is AAA which denotes highest safety. Credit ratings of AA or A indicate high to very safety. You should look at the credit rating of the FD and make informed investment decision.
Taxation : Taxation of bank FDs and corporate FDs is the same. The interest paid by the FD is added to your income and taxed as per your income tax slab.
Points to consider for investing in corporate FDs
Interest rate : Different NBFCs offer different interest rates on their FDs. You should compare different FDs and make informed investment decisions. However, you should also take credit risk into consideration.
Credit risk : Credit risk refers to the NBFC's failure of meeting interest and / or principal payment obligations, exposing the investor to potential loss of income and / or capital. You should consider the credit rating of the instrument and make informed investment decisions.
Tenures : Corporate FDs may offer different interest rates for different tenures; interest rates are usually higher for longer tenures. You should decide as per investment needs.
Mode of interest pay-out : Corporate FDs offer both periodic (non cumulative) and cumulative interest pay-out. In periodic interest payout, the interest will be paid to monthly, quarterly, half yearly or yearly; the rate of interest will differ for different pay-out intervals. In cumulative interest pay-out the interest is re-invested and you get the benefits of compound interest. You should decide on cumulative or non cumulative interest depending on your investment needs.