When considering a fixed deposit (FD) investment, you often face the dilemma of choosing between bank and corporate fixed deposits. Here are the differences between the two options to make an informed decision tailored to your financial goals.
Safety And Reliability
Bank FDs
These are considered one of the safest investment options. Deposits are insured by DICGC, providing security up to Rs 5 lakh per bank.
Corporate FDs
These are not backed by a government guarantee.
Safety depends on the financial health and reputation of the issuing company.
Financial Health Of The Issuing Company:
The financial stability and strength of the company offering the FD play a critical role in determining the safety of your investment. If the company is financially robust with a strong track record of profitability and low debt, it is generally considered a safer investment. However, if the company struggles with financial difficulties, there's a higher risk of defaulting on the FD, potentially losing your principal amount.
Reputation Of The Issuing Company:
The credibility of the company matters significantly.
Established and well-known companies with a history of honouring their financial commitments are generally considered safer options. On the other hand, relatively unknown or less reputable companies may carry a higher level of risk. Investors should research the company's reputation, past performance, and creditworthiness
Interest Rates:
Bank FDs
Economic conditions and central bank policies influence rates.
Bank FDs are popular financial instruments in which individuals deposit a lump sum amount with a bank for a fixed period at a predetermined interest rate. The interest rate, or "in this context, is critical in determining the returns on your FD investment. Here's how rates work in the context of bank FDs:
Influence Of Economic Conditions And RBI Policies: The interest rates offered on bank FDs are influenced by the prevailing economic conditions and the monetary policy of the Reserve Bank of India, or the RBI. When the central bank wants to stimulate economic growth, it may lower interest rates to encourage borrowing and spending. Conversely, when it aims to control inflation, it may raise interest rates to reduce spending. These changes in central bank policies have a cascading effect on the interest rates offered by commercial banks on their FDs.
Variation Between Banks: Different banks may offer varying interest rates on their FDs. This variation can result from factors such as the bank's cost of funds, market competition, and financial objectives. As a result, it's common to find differences in FD interest rates when comparing different banks.
Tenure And Market Conditions: The FD interest rate can also vary depending on the chosen tenure (the duration for which you lock in your money). Generally, longer-term FDs offer higher interest rates than shorter-term FDs. Additionally, market conditions, such as the overall interest rate environment and demand for credit, can influence the rates offered on FDs.
Rates may vary between banks, tenure, and market conditions.
Corporate FDs
Generally, they offer higher interest rates due to corporate funding needs. Corporate FDs provide a higher interest rate than bank FDs, typically 0.75 to 1.5 per cent higher. Several corporate fixed deposits with AAA ratings offer interest rates exceeding 8 per cent. Depending on the company's policies, senior citizens can additionally benefit from increased interest rates, ranging from 0.25 to 0.5 per cent.
Liquidity
Bank FDs
Offer moderate liquidity, often allowing premature withdrawal with a penalty.
Corporate FDs
These FDs may have longer lock-in periods, limiting access to funds.
Corporate FDs often come with more extended lock-in periods than bank FDs, and the specific duration of the lock-in period can vary significantly between corporate FDs. While providing an exact range for the lock-in periods is challenging, they can typically range from a few months to several years.
Here are two examples to illustrate the variation in lock-in periods for Corporate FDs:
Company A's Corporate FD: Company A offers a Corporate FD with a lock-in period of 36 months (three years). This means that once you invest in this FD, you won't have access to your principal or earned interest for three years.
Company B's Corporate FD: Company B, on the other hand, provides a Corporate FD with a lock-in period of 60 months (5 years). This FD requires investors to keep their funds locked in for a longer period than Company A's FD.
It's important to note that the lock-in period can vary between companies and within the same company, depending on the specific FD scheme they offer. Therefore, investors should carefully review the terms and conditions of the FD, including the lock-in period, before making an investment decision. Longer lock-in periods can limit liquidity, which may or may not align with an investor's financial goals and requirements, so choosing an FD that suits your financial situation and objectives is crucial.
Taxation
Bank FDs
Interest is subject to income tax as per your tax slab.
Corporate FDs
Interest earned on Corporate FDs is taxable, and the Tax Deducted at Source (TDS) rates can vary based on several factors. The primary reasons for varying TDS rates on interest from
Corporate FDs are as follows:
Income Tax Slab Rates: TDS rates on interest income are influenced by the income tax slab rates applicable to an individual. Individuals falling in higher income tax brackets are subject to higher TDS rates. The TDS is deducted at a rate corresponding to the individual's estimated annual tax liability based on income.
Interest Amount Threshold: The TDS rate may also vary depending on the total interest income earned during a financial year. Sometimes, TDS is deducted when the total interest income exceeds a certain government threshold. If your interest income is below this threshold, no TDS is deducted.
Form 15G/15H: Individuals eligible to claim exemptions from TDS, such as senior citizens or individuals with total income below the taxable limit, can submit Form 15G or 15H, respectively, to the bank. These forms declare that their income is below the taxable limit, so TDS should not be applied.
Residential Status: TDS rates can also vary based on the individual's residential status (resident or non-resident). Non-resident individuals may have different TDS rates applicable to their interest income.
Specific Company Policies: Some corporate FD issuers may have their policies for TDS rates based on the terms and conditions of the FD. They may deduct TDS at a specific rate, as their policy mentions.
Credit Rating
Bank FDs
Banks do not have credit ratings, which are considered safe due to government backing.
Corporate FDs
It is critical to check the credit rating of the issuing company. Higher-rated companies are considered safer investments. AAA or AA+ ratings are considered to be the best. Checking the issuing company's credit rating is crucial when considering investments in Corporate FDs.
Higher-rated companies are generally considered safer investments because they are less likely to default on their financial obligations. AAA or AA+ ratings are among a company's best credit ratings. Here's where you can find information about a company's credit rating:
Credit Rating Agencies: Credit rating agencies assess and assign credit ratings to companies based on their financial health and creditworthiness. Some prominent credit rating agencies include CRISIL, ICRA, CARE Ratings, and India Ratings and Research (a Fitch group company). You can find credit ratings and reports on these agencies' websites or by contacting them directly.
Company's Official Website: Some companies may provide information about their credit ratings on their official websites or in their annual reports. This information is often found in the investor relations section or financial disclosures.
Stock Exchanges: If the company is listed on a stock exchange, you can access its financial statements and credit ratings through the exchange's website or financial databases that track listed companies.
Lock-In Period
Bank FDs
They generally offer more flexibility with shorter lock-in periods. Many banks allow premature withdrawals, although they may involve a penalty or reduced interest rate.
Corporate FDs
They tend to have longer lock-in periods compared to bank FDs. Investors may not have access to their funds for an extended duration, which could be a disadvantage if liquidity is a priority. Corporate FDs typically come with longer lock-in periods when compared to bank FDs.
A lock-in period refers to the duration during which investors are not allowed to withdraw their invested principal or earned interest. This longer lock-in period can be a disadvantage for investors, mainly if they prioritize liquidity. Here's an elaboration on how this extended lock-in period can impact investors:
Reduced Liquidity: The primary drawback of a longer lock-in period is reduced liquidity.
Unlike bank FDs, which often offer various tenures, including short-term options, corporate FDs might have several years of lock-in periods. During this time, investors may not have access to their funds. This can be problematic if they encounter unexpected financial needs or emergencies requiring immediate savings access.
Limited Financial Flexibility: An extended lock-in period can limit an investor's financial flexibility. It ties up their capital for a substantial period, making it challenging to reallocate funds to more promising investment opportunities or address changing financial goals.
Opportunity Cost: Money invested in a corporate FD with a lengthy lock-in period may miss out on other investment opportunities that could offer higher returns. In a dynamic market, not being able to take advantage of potentially more profitable investments can result in an opportunity cost.
Risk Assessment: Investors should carefully assess their financial situation and risk tolerance before committing to a corporate FD with an extended lock-in period. In case of unforeseen circumstances or changes in financial goals, the inability to access funds can be a significant inconvenience.
Impact on Financial Planning: Longer lock-in periods can affect an individual's overall financial planning. It's essential to align the tenure of the FD with your financial objectives and ensure that the funds allocated are not crucial for addressing immediate financial needs.
Says A.K. Narayan, CEO of AK Narayan Associates, a financial planning firm: "Before choosing a corporate fixed deposit (FD), make sure it fits your investment goals. Investors looking for higher returns and comfortable with risk may choose corporate FDs due to better interest rates. But remember two things: don't invest all your money in one corporate FD, even if it offers the highest returns. Diversifying your deposit portfolio helps mitigate risk"
Choosing the right fixed deposit depends on your financial goals, risk tolerance, and investment horizon. For safety and liquidity, bank FDs may be preferred. Corporate FDs can be an option if you seek higher returns and are willing to manage risk, but always consider the credit rating to assess safety effectively.
