Corporate FDs
Many corporates, listed and unlisted, offer fixed deposit schemes that are seemingly more attractive than bank FDs. Corporate FDs offer higher interest rates than bank FDs and investors seeking higher returns invest in corporate FDs.
Corporates require RBI permission to accept deposits and they also have to be rated by credit rating agencies for investors to be aware of the safety of their capital. Corporates have FD schemes for investors, as such FDs offer stability of funds. In times of market stress where corporates access to funds gets cut off, FDs offer a more stable source of funds.
However, over the years, many corporates have defaulted on their FDs to investors, and these have gone largely unnoticed as they affect a few small investors who do not have the clout of the market to pull up defaulting corporates.
Investors take higher risk in corporate FDs
Investors mistake FDs as risk free as they believe all FDs are like bank FDs. This is not the case as bank FDs have a guarantee up to Rs 5 lakhs and even if bank goes under, retail depositors get their money bank. RBI too tries to protect all depositors through forced mergers.
Corporate FDs are not like bank FDs and do not have guarantee or RBI oversight. The investor in a corporate FD is completely dependent on the governance of the corporate to protect their interest and many such corporates do not have such governance. There are the very best of corporates whose FDs are as safe as bank FDs but their rate of interest will be as low as bank FD rates.
Corporate FD investors have to constantly evaluate the strength of the corporate to make sure their money is safe, and this is not possible for most investors.
Corporate bonds are less risky than corporate FDs
Corporate bonds while similar to corporate FDs as they pay regular interest and give principal back on maturity, are less risky than corporate FDs. The reason is that the bonds are widely held, have very high market scrutiny and also have regulatory oversight. A company issuing bonds will have to constantly update information to both market and rating agencies and the market determines the risk of the bond.
When a company is perceived to be risker by market, the company faces higher borrowing costs and also risk of lenders to stop lending, which will place the company’s operation in danger of getting stopped. Hence companies try their best to make sure that they are able to service bond holders.
Corporate bonds also offer exit to investors as they are liquid.
Investors are better off in corporate bonds than corporate FDs unless the corporate is extremely sound fundamentally.
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