Investors, particularly senior citizens, who are dependent on interest income and look for safer investment avenues, find fixed deposits as one of the most preferred investment options. However, they remain in a state of bewilderment when they have to make the actual decision and choose one from the plethora of options available.

Based on three criteria - interest rates, risk of investing, and taxation issue, let us find out which one can be tagged as a better investment product. Fixed Deposits (FDs) offered by banks or the corporate FDs?

Below is an attempt to clarify the issue.

What is a Bank FD?

These are deposits with scheduled banks for a pre-defined period, which could range from a few days to many years. Banks offer fixed interest rates, depending on the prevailing interest rates in the economy. Various maturity options are provided by banks, where the deposit can be automatically renewed on maturity or credited back to the account of the customer. Similarly, the investors can choose to reinvest the interest or to withdraw only the interest amount at fixed intervals.

Bank fixed deposits have traditionally been the most popular way for Indians to park their savings for two reasons – Trust and Access. Since the banking sector is highly regulated and there have been negligible cases of defaults, the bank fixed deposits are treated as the most secure form of investment. Secondly, there are bank branches in every nook and corner of the country, where most people have their savings accounts. So, opening a fixed deposit with the same bank branch was the easiest form of earning a return higher than the savings account. Further, since the interest rates are assured, the calculation of the expected return is very convenient leaving little doubt in the minds of investors.

Bank deposits up to Rs 5 lakh are also secured by way of an insurance scheme of RBI, which is mandatory for banks. So, in case of a collapse of a bank, fixed deposit holders are safe to that extent.

What is a Corporate FD?

Large Non-Banking Finance Companies (NBFCs) (example – Bajaj Finance, HDFC) are also in the business of borrowing and lending money. Raising money through fixed deposit schemes from retail investors has been a very popular and cost-effective method for them. These deposits typically offer higher interest rates compared to a bank fixed deposit. The period of deposit could range from one year to 10 years and investors could either withdraw the interest regularly or can opt to reinvest the interest in the same fixed deposit, in which case the overall return will be higher. There is an option to break the deposit before maturity, where there could be a penalty applied on the maturity amount. These deposits are rated by rating agencies like CRISIL and ICRA. The ratings indicate the ability of the company to service interest payments.

Comparison of Bank FDs and Corporate FDs

Interest Rates: Corporate FDs typically have higher interest rates compared to bank FDs, and the difference could be to the tune of 0.5 per cent to 3 per cent pa, depending on the company and tenure.

Risks: Bank fixed deposits are the safest investment option. Even though there have been cases of some of the small/co-operative banks going under, yet the guarantee of protection up to Rs 5 lakh helps a lot. In the case of corporate fixed deposits, there is no guarantee of repayment and in case the company’s financial position deteriorates, there is a risk to both interest and principal. Investors need to choose the very financially strong company with the highest credit rating and constantly track the financial position of the company.

Taxation: The taxation structure for both bank and corporate fixed deposits is similar. Interest income is added to the total taxable income of the investor.

To conclude, investors can get higher interest with a corporate fixed deposit compared to a bank fixed deposit. But, they need to choose the right company, which has a strong financial position and highest credit rating, to ensure that their principal and interest income remains safe.

The author is CEO & Founder, Nivesh.com

DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.