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Companies FDs offer higher rate, but bank Fixed Deposits safer

 

 

TERM deposits are a very common form of investment for individuals as well as corporate investors. It is free from market volatility risk because the rate of interest is contractual. Hence, the only variables are rate of interest and credit risk. Obviously, the higher the credit risk, the higher would be the return on the deposit. The investor has to make a choice, whether to settle for a relatively lower rate of interest with relatively higher safety or a marginally higher return on the investment with a higher risk perception.
 
Let us then look at the degree of safety on deposits with banks and companies.

With banks, more so with nationalised banks, the perceived safety level is of a very high degree due to the nature of ownership of the institution and track record.


However, technically, there is no guarantee on deposits. There is a Deposit Insurance and Credit Guarantee Corporation (DICGC) Act, under which a bank can take insurance cover for deposits. It is up to Rs 100,000, which means even if a bank takes cover for deposits under the DICGC Act, deposits higher than Rs 100,000 are not guaranteed. However, there is an implied moral responsibility of the government on banks regulated by the RBI, which makes these deposits safe. There have been instances where a bank was in trouble and RBI stepped in and merged the troubled bank with a stronger bank so that all depositors' moneys were safe. This bailout is not just applicable for nationalised banks but for private sector banks as well. There is a cash reserve ratio (CRR) that banks have to maintain with RBI, so that if there is a run on deposits, RBI will step in with cash. From this perspective, it is better to place deposits with scheduled commercial banks that are mentioned in RBI's schedule.

Deposits with companies do not have the moral support of RBI or government of India. There is a provision in the Companies Act (Section 58A) that states that a pre-condition for acceptance for deposits is that "the company is not in default in the payment of any deposit or part thereof and any interest thereupon in accordance with the terms and conditions of such deposit".


Section 58A also states that "Where a company has failed to repay any deposit . .
. the tribunal may direct, by order, the company to make repayment of such deposit". Section 58AA of Companies Act states that "Every company, which accepts deposits from small depositors, shall intimate to the tribunal any default made by it in repayment of any deposits". In addition, there is Companies (Acceptance of Deposits) Rules, 1975, which lays down the ground rules.

Investors should go by the credit rating of the company and track record in servicing deposits. Credit rating is not any guarantee, but the opinion of the rating agency on the debt-servicing ability of the company may be used as a proxy for the fundamental quality/cash flows of the company.

On the parameter of flexibility of premature withdrawals, banks are marginally better because the penalty is somewhat lower. However, premature withdrawal should be the last option for a depositor's cash requirements and not be the guiding principle for making deposits.

To summarise, banks offer a higher perceived level of safety on deposits and corporate de posits offer a marginally higher rate of interest to compensate for the relatively higher risk perception. As of now, banks are offering interest rates in the range of 8.25 per cent to 9 per cent for one-year deposits (additional interest for senior citizens), where as companies with credit rating of AA+ and above are offering interest rates in the range of 9.25 per cent to 10 per cent for one-year deposits (there may be additional interest for senior citizens). There is no major problem in availing of 1 per cent higher interest rate in a corporate deposit, if the investor so wishes, as long as it is a highly rated private company. For a company rated lower than AA+, the investor should look at whether the additional risk and additional return are reasonable.

 

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