7 Factors to Look at When Investing in Corporate FDs

When speaking of fixed deposits, most people think of only bank fixed deposits. What if I tell you there is a better option than a bank fixed deposit - a corporate fixed deposit, which can offer better interest rates than a bank fixed deposit? Yes, a corporate fixed deposit can offer a 1% to 3% more interest rate than a bank fixed deposit. However, these fixed deposits are considered unsecured as they are not backed by any insurance. Read on to know more about corporate FDs and the factors to look at when investing in them.

What are Corporate Fixed Deposits?

A corporate fixed deposit, also known as a company fixed deposit, is a type of fixed deposit issued by corporates/companies, including Non-Banking Financial Companies, Housing Finance Companies, and other financial organisations. Similar to banks, these companies collect deposits for a fixed tenure at a prescribed interest rate. Like banks, these deposits come with guaranteed returns and flexibility to choose the tenure as per your requirements.

Additionally, corporate FDs offer higher interest rates than that of banks. So, these FDs are ideal for those looking to invest in fixed deposits but expect a slightly higher interest rate. That said, take note that risk and returns go hand in hand, and the higher returns in corporate FDs account for a higher risk. There have been many incidents of corporates delaying interest and principal payments over the past few years. Hence, before investing your hard-earned money into corporate FDs, it is necessary to understand how they work.

Here are 7 factors to look at when investing in Corporate Fixed Deposits:

1. Company's Track Record:

Many investors check the company's ratings given by rating agencies like CRISIL, CARE, ICRA, etc. and make a decision. However, it is important to understand that a higher rating does not guarantee the safety of your deposits. Apart from checking the ratings, you should also check how the company has performed in the past in terms of profits. If a company is consistently profitable, with one or two exceptions, you can consider it a positive record. Moreover, it is also advisable to research on company's plans and analyse its impact.

2. Potential Risk:

Corporate FDs come with a default risk of investors prematurely withdrawing their deposits. This can push the corporate into a cash crunch situation, which further results in delayed repayments. There could be several situations where a company may find it difficult to repay even the principal amount. Therefore, before investing in a company FD, an investor must have knowledge regarding the liquidity situation of the company.

The rating agencies like CRISIL, ICRA, etc. rate corporate FDs based on their credibility, which can help you make an informed decision. It is advisable to prefer corporate deposits of companies with AA or higher ratings. However, bear in mind that a higher rating is not a guarantee of safety, and there is always an element of risk.

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3. Security of Your Funds:

While corporate FDs offer higher interest rates than bank FDs, they are not as secure as bank FDs. As you might be aware, the Reserve Bank of India (RBI), through its subsidiary Deposit Insurance and Credit Guarantee Corporation (DICGC), provides insurance on deposits held by customers in banks, including commercial banks, cooperative banks, and small finance banks. DICGC protects depositors' money which is kept in a bank, provided the bank has opted for DICGC cover. Effective 4th February 2020, the Bank Deposit Insurance covered under DICGC was raised to Rs 5 Lakhs from the earlier cover of Rs 1 Lakh. So, now you are insured for up to Rs 5 Lakhs of bank deposit (principal +interest).

However, corporate FDs are not covered under such insurance. In case the company goes bankrupt, your invested money will be at risk. Since the companies do not guarantee the repayment of your principal and payment of interest, the company FDs are considered unsecured. If the company delays the payment, the depositors cannot do anything but wait.

4. Regulations:

Bank FDs are governed by the Banking Regulation Act 1949, which strictly abides by the regulations of the RBI. Whereas corporate FDs are monitored by the corporates themselves and governed by the provision of Section 58-A of the Companies Act 1956. As per the Act, if the company is in a challenging financial situation, it has to prioritise its equity shareholders over fixed deposit holders. This makes even the best corporate FDs riskier.

5. Interest Rate:

The interest rate on bank FDs and corporate FDs vary across banks and corporates. Many depositors get lured by the unusually higher interest rates offered by corporates and risk their capital by investing in companies that later go bust. Therefore, it is best to take necessary precautions so as not to get lured by the ones offering an extraordinarily higher interest rate than the market rate.

When you are investing in a financial instrument that offers low risk and low returns, your objective should be to yield a competitive interest rate on your principal for the tenure you choose.

6. Liquidity:

Generally, corporate FDs come with a tenure of 1 year to 5 years. This is a period for which you want to deploy your capital in a fixed deposit. You can choose the FD tenure based on your investment goal. If you need the money before the end of the FD tenure, you can opt for a premature withdrawal.

However, most companies have a lock-in period of 3 to 6 months for corporate deposits, during which you cannot withdraw your funds. Besides, companies typically charge for a premature withdrawal for liquidating your investment before the end of the tenure, and this results in receiving lower interest than you expected. You should choose the corporate FD with a minimum lock-in period and premature withdrawal charges.

7. Taxation:

If your interest earnings exceed Rs 5,000 in a financial year, the company will deduct TDS (Tax Deducted at Source) at 10%. In case you fail to provide your PAN details to the company, and your interest earnings exceed the above-mentioned threshold limit, the company will deduct TDS at 20%. If you are a senior citizen and your total income from investments does not exceed Rs 2,50,000, you are required to submit a 15H form.

The Income Tax Act treats the income from fixed deposits as 'income from other sources', making it fully taxable. So, following the prevalent tax laws, the earnings from your bank FDs and corporate FDs are included in your gross annual income to estimate the tax liability. So, if you belong to the 30% tax bracket, the returns after tax from a company FD may not even beat the prevalent inflation.

Should you invest in Corporate FDs?

If you are a conservative investor who is averse to taking a risk, wants to park money for the short-term, is looking for liquidity, or wants to plan for contingency needs, a bank FD is a worthy option for you.

While the higher interest rate is alluring, it is crucial to understand the risks involved. So, it may make sense to invest a small portion of your total investments in corporate FDs. It can prove to be a good investment if you are willing to take additional risks to gain extra returns in the short term and do thorough research before investing. It will also be beneficial if you diversify your investment in corporate FDs across multiple companies.

But note that fixed deposits are tax inefficient compared to mutual funds and hence may not generate inflation-adjusted returns. Besides, you may predict the company's performance in the short term, but you don't know what can affect the company in the long term.

If you are willing to take a market-linked risk, investing in carefully selected equity mutual funds can help you generate superior returns to achieve your financial goals. PersonalFN's Financial Planning Service can help you achieve your goals through a smartly done equity mutual fund investment that generates inflation-beating returns while reducing the risk with a diversified portfolio.

Warm Regards,
Ketki Jadhav
Content Writer