Corporate fixed deposits offer higher rates than banks. But is it safe and smart to go for them?  

June 14, 2011

There are a few precautions you must take before you are tempted to put your money in corporate fixed deposits

Moneylife Digital Team

Interest rates offered by banks on their fixed deposits are on the rise. Today banks are offering 8.25% on deposits of more than a year and 9% for deposits of more than two years. These are attractive, but there are even more attractive deposit options from companies looking to raise funds. These include non-banking financial companies (NBFCs) that are raising money from savers at attractive rates.

The rate of interest is determined by the tenure of the deposit as well as some other factors. The deposits are governed by section 58A of the Companies Act. The table below offers some corporate FDs which are currently on offer. The interest rates offered by some companies are substantially higher than that offered by banks.



Is it worth putting money in these FDs to get a couple of percentage points of extra interest? Like bank FDs, they are a good source of monthly, quarterly, half-yearly, or yearly interest income. The tenure is flexible, ranging from six months to seven years. The other benefits are that no tax is deducted at source in case the interest is only up to Rs5,000 in a year. They have a nomination facility and the operational process is simple too-even PAN is not required.
However, higher the interest rate, the more the risk that is associated with it.

Thus, a company offering 15% interest rate would be riskier than that offering 11%. These deposits are not secured, unlike in banks where deposits up to Rs1 lakh are covered by a deposit insurance. Besides, deposits with public sector banks are totally safe. It is inconceivable now that the government will let the depositors of any public sector bank down. But in the case of default by a company, the investor is likely to lose the money. Besides, the investor has no claim over the assets of the company in case the company is to be wound up. That makes corporate FDs risky and, therefore, they attract a higher interest.

In order to protect ones investment from risk, the performance of the company must be reviewed before investing. Also at the time of maturity, if you wish to reinvest your amount, check the company's performance. Keep a regular check on the companies in which you plan to invest by keeping a track of its balance sheet and share prices. This will enable you to decide your investment in corporate fixed deposits. Before investing, ensure that you choose companies that have a good credit rating (A or above).

Here are some guidelines on company fixed deposits that you should avoid.
Companies which offer interest rates that are up to 3% higher than that offered on bank FDs.
Companies that are not paying dividends to the shareholder.
Companies whose balance sheet show losses.
Companies which are below investment grade (A or under) rating.
Unlisted companies, as it is very difficult to judge their performance.
If you wish to get higher returns, you must take a little risk. And if you wish to avoid the risk, you must compromise on the returns. However, when deciding on your option for corporate FDs, it is important to know how to choose the proper fixed deposit and how to ignore the wrong ones. Here are a few tips to ensure higher returns with low risk.

Spread your risk by spreading your investment in fixed deposits over a number of companies in different businesses. Do not put more than 10% of your investment in one company. This has two benefits. First, your risk will be diversified among various industries. Second, the interest from one company may not exceed Rs5,000, and hence there will be no tax deducted at source (TDS).

Choose the right tenure of deposit. Ideally you must invest for a period of one year. Blocking your investment for more than one year could be risky, because the performance of the company cannot be assured over a long period of time.

Make a periodic review of the company from time to time and at the maturity of the deposit. This will help you to decide whether you should renew or reshuffle the deposit. In the case of company fixed deposits, it is necessary to check whether they have been rated by agencies like Crisil, Icra, etc. Also check the number of years that the company has been in business, the profitability of the company, the and the reputation of the promoters.  If you know of people who have invested in company fixed deposits, try to find out if these companies have been prompt  in sending maturity proceeds, interest cheques, and how responsive they are to queries.