With interest rates at an all-time low, bank fixed deposits (FDs) rates are currently in the range of 5.1- 5.7 per cent for five-year tenures. In fact, in a lot of cases, real returns from bank FDs have turned negative.
Corporate FDs, on the other hand, are offering a higher rate of return, in the range of 7-9 per cent or even more. While getting a higher rate of interest on deposits can be attractive, it may also entail higher risk. Here are some things to keep in mind before investing in corporate deposits.
How Are Corporate FDs Different Than Bank FDs?
“Both the FDs (bank and corporate) differ from each other in terms of the interest they offer and the risk they carry to provide the difference in the interest rates,” says Hemant Beniwal, certified financial planner and director at Ark Primary Advisors, a financial planning firm.
The bank FDs are backed by the overall assets that banks manage, which gives them a huge volume even at low interest. Corporates do not enjoy this advantage due to which they have to offer high interest rates to raise money.
Banks earn net interest margin or the differential what they pay for FDs to customers versus what they charge on loans (including home and corporate loans). On the other hand, companies borrow money from people and use it to generate higher returns for the customers.
Consider Higher Risk
“Bank deposits are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) up to an amount of Rs 5 lakh and are being regulated by the Reserve Bank of India (RBI),” says B Srinivasan, a certified financial planner.
However, corporate FDs are backed by no such insurance. “Higher returns in corporate deposits come with a higher concentration risk and default risk. So, one needs to be aware of the risk one is exposed to in these,” says Srinivasan.
There are other risks too in corporate FDs, so here’s what you should consider before investing. “First, study the risk of corporates offering the FD (such as liquidity and creditability). Then know your objective (safety of capital, high returns, period of investing). Finally, know the objective of the promoter for raising the FDs,” says Beniwal.
When investing in corporate FDs, look at a AAA rating. “Certain AAA-rated deposits offered by companies like HDFC or Sundaram Finance are comparable to bank deposits,” says Srinivasan.
However, the AAA rating is not a guarantee of safety and there is always an element of risk. “In the past, we saw the fall of many AAA-rated big houses,” says Beniwal.
What should you do?
It may make sense to invest a small portion in corporate FDs and not invest everything in them.
“Corporate FDs could be a good instrument to invest for a person who is willing to take additional risk to gain additional return in the short term but one important thing is the allocation of our investments towards it. A small exposure in this could be a good move but putting a major chunk of money into it because of the tempting gains could ruin your finances,” says Beniwal.
But the diversification factor needs to be considered carefully. “In diversified equity, the risk is reduced with time, but in debt, it's the opposite. In the short term, there is visibility that how a company will perform, but in the long term, we don't know what can hurt the organization,” says Beniwal. Hence, you should avoid locking in your money in corporate deposits for a higher tenure.