Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Are company FDs as attractive as they look?

The higher interest rate comes at the cost of safety that a bank deposit offers.

Last week, IDBI Bank Ltd cut interest rate on deposits of select maturity periods by 50 basis points. Analyst and bankers, however, say that banks will not cut deposit rates immediately but it will happen in coming months.

Considering that deposit rates will fall, you may get attracted to company fixed deposits (FDs) due to the better returns they offer. Company FDs are just like your deposits with banks—you can put your money with companies in deposits run by them. Known as company deposits, these carry a specified rate of interest over a fixed tenor. Currently, company deposits with AAA rating give you 1-2% higher interest rate than bank deposits. For instance, an FD with Mahindra and Mahindra Financial Services Ltd gives 10.25% returns, while State Bank of India, the country’s largest bank, fetches you 9% returns for a three-year tenor.

But you should remember that a 1-2% increase in interest rate comes along with higher risk and more work for you in terms of researching about the company’s financials and other issues. So here are five things to consider before you buy a company deposit.

Risk of default

Unlike bank FDs, company deposits are not secure. Though non-banking finance companies (NBFCs) are regulated by Reserve Bank of India and others by the Registrar of Companies, you still have the risk of losing your money.

These deposits are unsecured, which means that if the company is unable to meet its commitment, you stand to lose your principal. However, in case of bank FDs, 1 lakh is always insured by your bank by the Deposit Insurance and Credit Guarantee Corp. Says Anil Rego, a Bangalore-based financial planner, “Mostly conservative investors go for FDs as they want the capital to be protected. In case of company deposits, your capital can be at risk as we have seen real estate companies and NBFCs defaulting in the past."

Avoid long-term deposits: If you want to invest in company deposits opt only for shorter tenor deposits. Says Rego, “You will not know about the business cycle of a company for a five year period. It would be less risky to invest in short-term company deposits."

Credit rating

One way to assess the risk of default is by assessing the company’s health, which you can do through credit ratings.

Company deposits generally come with credit ratings. Crisil normally rates company deposits, the highest rating being FAAA, which denotes high level of safety. In other words, with such a rating, the chances of defaulting on payment of interest and principal are minimal. Says Vishal Dhawan, a Mumbai-based financial planner, “It is mandatory for financial institutions such as Mahindra & Mahindra Financial Services, Dewan Housing Finance Co. Ltd and LIC Housing Finance Co. Ltd to give a rating."

Don’t invest in any company FDs below AA rating as it is very risky. So if you are opting for company FDs from any financial institution, then do look at ratings. Says Suresh Sadagopan, a Mumbai-based financial planner, “To a certain extent, you can get a fair picture of company deposits through credit rating. Also besides credit rating there is no other way to understand the product at a glance."

But what if a company does not provide a credit rating at all? We would advise you to stay away but in case you still want to consider it, look at the company’s financial health. Says Dhawan, “Manufacturing companies that provide company deposits are not obliged to give a rating. Hence, the ways to understand the health of such a deposit would be to look at the company’s balance sheet." Looking at a balance sheet may not be possible for a lot of retail investors, who may not have the time or may not be equipped enough to assess such a document.

Says Sadagopan, “While looking at the balance sheet and profit and loss account of the company see if the company is making consistent profit for at least three years." A decline in profit is a red flag. A periodic review of the company every quarter will help you decide whether you should continue to be invested in the company.

Premature withdrawal

The liquidity in company FDs is lower than in bank FDs. Says Sadagopan, “In case of emergency where a lump sum amount is required people terminate their FDs. Bank FDs can be withdrawn any time unlike company deposits where in most cases you don’t have to option to get the money in the first three months."

A bank FD can be terminated by paying a penalty. While you will get the interest your money earned during the period till which you withdraw prematurely, the interest you will get would be 1% less than the promised in most cases.

The costs for premature withdrawal of company FDs are much higher. For instance, Mahindra and Mahindra Financial Services states on its website that if you want a premature withdrawal within six months from the date of the FD, you will not get any interest on your investment. After six months, the interest rate paid to you will be 2% lower than the interest rate applicable. In case of Dewan Housing Finance, if you withdraw your money prematurely after six months but before 12 months, you will get 3% less than the promised rate.

You need to be cautious while investing in company deposits. Apart from the risk that such deposits carry, the sheer research you need to do before you buy these take away the ease we associate with making fixed deposits with banks.

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