NRIs: How good are bank fixed deposits when compared to corporate deposits in India?
Delving into an age-old debate for investors looking to spend on fixed deposits
A popular form of one-time investments, fixed deposits (FDs), have proved to be appealing products that gets most Indian investors hooked. But hotly debated topic is to find out – among FDs – which is better, corporate or bank-issued fixed deposits.
However, before we delve into the details into which of the two is better, let’s quickly brush up on what they are and what makes them unique.
Fixed deposit products (FDs), single-time investments that cannot be withdrawn for an agreed upon length of time, is popular because of the fixed nature of the ‘term of the investment’ and the ‘interest rate’.
(The ‘term of the investment’ or ‘maturity period’ or ‘tenure’ refers to the lifespan of any investment or how long the money will remain invested, which is a time period (term) set by the issuer. The ‘interest rate’ is nothing but a percentage of the money lent charged by the lender for the use of its money.)
Fixed deposit products (FDs), single-time investments that cannot be withdrawn for an agreed upon length of time, is popular because of the fixed nature of the ‘term of the investment’ and the ‘interest rate’.
Corporate, bank issued fixed deposits (FDs)
The two prevalent forms of FDs include deposits issued by banks and companies. Banks are known to be the biggest issuers of fixed deposit products in India. Since banks inherently have the trust of their customers, and since they already have the customer’s money, investors find it easy to choose them.
However, there are other institutions that offer similar deposit products to investors – these are companies that are not registered as banks (or any lending or financing institutions). They could be running several businesses and may require capital for operating them. When they do, they issue deposit certificates to investors of different tenures at fixed interest rates.
Higher rates?
Typically, the interest rate offered by corporate fixed deposits are higher than the ones offered by banks. For this reason, investors choose to include corporate fixed deposits in their portfolio.
Although company deposits offer a higher interest rate, they come with higher risk and more stringent conditions generally. Investor can invest in company fixed deposits if they want higher returns and can take a bit higher risk. However, a good credit rating can point towards a safer company fixed deposit.
Although company deposits offer a higher interest rate, they come with higher risk and more stringent conditions generally.
To take interest-rate advantage, it is advisable to invest in fixed deposit for short term. The interest rates offered by banks hardly beat inflation. Moreover, when tax is deducted from the interest income, returns on fixed deposit may fall below the rate of inflation.
Rate comparison
In India, banks like State Bank of India (SBI), HDFC Bank, ICICI Bank, Axis Bank and Punjab National Bank offer fixed deposit interest rates up to 7 per cent. Small finance banks like Fincare Small Finance Bank, AU Small Finance Bank, Ujjivan Small Finance Bank and Equitas Small Finance Bank offer fixed deposit interest rates up to 9 per cent.
Companies rated higher by different global credit agencies (we will discuss ratings in detail below) offer interest rates between 9.25 to 10.75 per cent, on corporate FDs of tenures varying from 1 to 5 years. Companies with a lower rating offer higher interest rates than the highly rated ones to make up for the risks.
As discussed earlier, the company deposits give a slightly higher interest rate because there is a slightly higher risk associated with them. Let’s now look in detail at what are the risks associated with both.
Risks involved
Default risk – Bank fixed deposits are secured by Reserve Bank of India up to INR 500,000 (Dh24,831) which means that each depositor will get this sum if a bank goes bankrupt or does not pay back one's money. However, corporate fixed deposits do not offer any such security and these are not backed by collateral and are unsecured in nature.
The company might suffer heavy losses and be out of funds. It might default on interest payments and might not return the mature amount. Thus, this makes corporate fixed deposits a very risky investment. In order to compensate this risk, companies offer higher interest rates on fixed deposits than banks.
The higher the credit risk, the greater is the interest rate offered.
The higher the credit risk, the greater is the interest rate offered. So investors rely on the reputation and the credit rating of the corporate when investing in them.
Credit Risk – Corporate fixed deposit may be more preferred than bank deposits given the equivalent credit rating and higher rate of interest. But experts say customers must ensure that they invest in high-rated corporate deposit with AAA or equivalent rating, and avoid choosing low-credit rating company (with C or D ratings). To find the rating from various agencies including S&P, Moody's, Fitch, CRISIL, CARE, ICRA, Ratings India Pvt. Ltd. and Brickwork Ratings Pvt. Ltd, check rating profile (CRPR) assigned to different companies in each of brokerage’s websites.
But there have been rare exceptions where credit rating agencies have gone wrong on ratings multiple times in the past.
The crisis in Dewan Housing Finance Corporation and subsequent helplessness of investors stuck in its FDs hold a lesson.
The crisis in Dewan Housing Finance Corporation and subsequent helplessness of investors stuck in its FDs hold a lesson. The rating agencies could not detect gradual deterioration in its financials and failed to give advance warning to the depositors. After the issue was already out in the open, the agencies quickly downgraded the company. However, investors got no time to react to the situation. The Mumbai High Court had barred the company to make payments to fixed deposit holders without the court's permission.
Taxation – Bank fixed deposits with lock-in periods (a period during which you cannot withdraw the amount) of five or ten years offer income tax benefits to Indian citizens under Section 80C of the Income Tax Act. Bank fixed deposits with facility to withdrawal before maturity period ends do not offer any tax benefits. If the interest income on bank fixed deposits exceeds INR 10,000 (Dh506) in a year, banks deduct tax at source. On the other hand, corporate deposits tend to deduct the TDS (tax deducted at source from where an individual's income is generated) if the annual interest exceeds INR 5,000 (Dh253).
#BEWARE: All fixed deposits (including bank fixed deposits) are taxed at the highest income tax bracket of the person (which depends on your overall taxable income). So, any returns being considered have to factor in the tax that you need to pay.
Premature withdrawal – A bank fixed deposit can be withdrawn prematurely by deducting a penalty of around 2 per cent on the interest rate. Some corporate fixed deposits do not allow premature withdrawal for a period of three to six months, but if a premature withdrawal is made, you’ll get the deposit as is. On premature withdrawal after 6 to 12 months, certain companies deduct around 2 to 3 per cent on the interest rate offered.
The above risks associated with a corporate FD should be factored in while making a decision on where to invest.
#TIPS: How to mitigate your risks when investing in company FDs?
- Spread your investments – An investor can choose between banks and companies when it comes to deposit options. Divide your deposit portfolio into equal parts for these categories.
- Choose your companies wisely – You shouldn’t use companies that are not rated by credit risk agencies regardless of how high a rate they offer, and preferably chose companies that are part of a larger group so the risk is mitigated.
- Go short-term when investing in companies – Choose the company deposits for the part of the portfolio that has the shortest tenure – say 1-2 years. An investor will then have the potential to make a good risk-adjusted return from their deposit portfolio.
So what’s your pick: Bank fixed deposits or corporate fixed deposits?
Investing in a corporate fixed deposit of a short tenure is the way to go rather than invest in deposits of a longer tenure. One does not know what the business cycle (of the company) would be over a longer period of time and deposits of a shorter tenure are generally safer to invest in.
However, corporate fixed deposit certainly don’t come nowhere near the ease and comfort of a bank fixed deposit. A thorough research is necessary to invest in a corporate fixed deposit in order to gainfully profit from the higher interest rates offered. The safest option is a bank-issued fixed deposit.
#NRIs: Non-residential Indians investing in Indian company FDs should keep in mind:
- Under certain conditions according to Reserve Bank of India, deposits should be debited only from the Non Resident Ordinary (NRO) account of NRIs and not from the Non Resident External Account (NRE Account).
- NRIs can also invest in company deposits provided the amounts would not be credited to a Non Resident External (NRE) account. Moreover, the amount that are received from the deposits are non-repatriable, which means you cannot transfer the money back abroad.
- Banks are free to determine their interest rates on savings deposits under Ordinary Non-Resident (NRO) Accounts.
An NRI can open two kinds of accounts in India - NRE (Non Resident External Account) and NRO (Non Resident Ordinary) accounts. While NRO accounts is meant for depositing earnings made in India in rupee denomination, NRE accounts is to deposit earnings earned in a foreign currency abroad.
NRE deposits VS NRO deposits
An NRE FD is a type of term deposit account where the NRI makes deposits from overseas and remit the same in an Indian account, where the currency will be converted into rupees. An NRE deposit is basically a term deposit account held to transfer foreign earnings. Interest earnings on NRE deposits are not taxed.
Additionally, NRI’s earning in a foreign currency has limited opportunities of both exchange rate and interest rate arbitrage to beat inflation in the home country, but excess borrowings abroad that are not adequately backed by future foreign currency earnings could result in losses in exchange rate, if the home currency is fundamentally weak and tends to depreciate.
NRO fixed deposits attract taxes as per Indian laws. The interests earned from an NRO FD are taxed according to the Income Tax Act, 1961 at around 30 per cent, which is quite high when compared to domestic FD tax rates.
NRE fixed deposits do not attract taxes on the principal or interests earned from the deposits. Consequently, NRE fixed deposits are completely tax free. This difference makes an NRE FD a better option than its NRO avatar.