What is a Fixed Deposit? (Company FD and Bank FD)
Cash deposits made by investors with a financial institution or a corporate house is a common practice. One financial instrument explored by every investor is the Fixed deposit. The tool enables a customer to deposit a minimum amount for a predetermined tenure and enjoy a fixed rate of interest. Banks refer to their financial instrument as Bank FDs while a corporate house will refer to it as a Corporate FD.
Though both the fixed deposit schemes have the same features, there are three inherent differences that you should be aware of before you reach a final decision.
Financial experts agree that bank fixed deposits are one of the safest forms of investments, especially when you opt for a public sector bank. They are governed by stringent regulations of the RBI and have government backing. Nevertheless, if the bank fails or goes bankrupt, the deposits are insured for only up to Rs 1 lakh in a deposit account as per the regulations of the Deposit Insurance and Credit Guarantee Corporation.
Company fixed deposits, on the other hand, do not provide the level of safety offered by a bank fixed deposit. You may end up losing the entire amount (both principal and interest) in case the company default. Therefore, it is necessary to research companies and invest in ones with a higher credit rating.
A credit rating agency is required to perform a comprehensive analysis of business and financial risks, management quality and ability to service debt before they assign a rating. The agency prefixes the fixed deposit with the letter F. As per leading rating agency Crisil, ‘FAAA’ would denote highest possible safety. It indicates that the ability to pay the interest and principal promptly is very strong. Similarly, ‘FAA’ would mean that the ability to pay the interest and principal is strong. A company with only an A rating is definitely not as strong. You will have to track the credit rating of the company to keep track of the rating and take immediate action if the rating drops.
With a public bank deposit, your money is not at risk, and you are assured that you will get your money back along with interest.
Interest earned from fixed deposits is subject to applicable taxes as per the Income Tax Act, 1961. As per the Act, tax is deducted at source on the interest earned from:
- Bank fixed deposit if the interest is more than Rs 10,000 in one financial year.
- Company deposits, if the interest is more than Rs. 5,000 in one financial year
As the risk associated with company fixed deposits is higher, they also offer a higher interest rate. They offer around 50 to 100 basis points higher rate of interest than the prevalent bank fixed deposit rates. A basis point is the smallest unit to measure yields for fixed income instruments. 1 basis point = 0.01%.
Therefore 50 basis points would mean 0.5%.
For instance, a leading nationalized bank would offer 6.6% to 7% as pre-tax interest rates for deposits with the range being 1 to 10 years. For senior citizens, this rate could from 7.1% to 7.5%. However, company deposits could offer interest rates between 8.2% and 8.9%. For senior citizens, this could be as high as 8.6% to 9.3%.
You have to know your risk appetite and financial objectives to make the decision. Risk-averse investors would be better off investing in a bank fixed deposit. Those with risk appetite can consider corporate deposits after adequate due diligence and research.