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Investing in company fixed deposits

Last Updated 22 January 2017, 18:56 IST
Interest on bank fixed deposits is headed south and likely to plunge further in these times of excess liquidity with the banks. It is a worry for a majority of retail depositors who supplement their income from interest earnings on bank fixed deposits. Their tight monthly budget gets affected when banks reduce their interest rates on fixed deposits. They look for alternatives to maintain the budgeted flow. As an optional debt investment, company fixed deposits seem attractive as interest rates offered are usually 2%–2.5% higher than the bank fixed deposits of one to three years tenure.

The risks in company deposits
Why it is preferable to stay away, as far as possible, from these company deposits? Let’s elaborate. The basic principle of investing is rooted in three core attributes that should be kept in mind. These are safety, liquidity and growth of your investments. While we cannot compromise on safety of our investment, we can be flexible with liquidity and growth depending on our need for funds and the risk that we may take.

Company fixed deposits do not score highly with the safety of our deposits as there are innumerable cases of default in payment. Liquidity of the asset automatically carries a question mark when the payment itself might be in doubt. In such a scenario, the higher interest rates have no meaning when the safety and liquidity of our deposit is under strain. There are instances of prolonged litigation that depositors have had to face to redeem their deposits. There is no safety net of an insurance cover which bank deposits in comparison enjoy upto Rs 1 lakh.

Many pensioners opt to have company fixed deposits to augment their resources and this inclination becomes acute when interest rates begin to fall. This choice is exercised simply to increase the returns from their savings. But company performances do not justify this faith of the depositors.

There are reasons why companies are likely to falter. At times, the projected growth of the company does not happen either because of the prevailing economic environment which might include a continuous stretch of high borrowing costs or a change in government policy. This affects the profitability of the companies leading to delays/defaults in payments. It could also be a case of tight liquidity with the companies because the projected funds flow does not materialise.

In all such eventualities, payment of fixed deposits by the companies is the first casualty. It is the easiest option for the companies as the fixed deposits of the retail investors are unsecured loans. These are given the least priority when it comes to payment of liabilities by the companies. What we need to bear in mind is that corporate fixed deposits are a cheap source of borrowing for companies without the need to pledge any security.  

In terms of available data on the performance of company fixed deposits, there are many instances of companies having either delayed payments or defaulted in the past. The problem gets accentuated when legal recourse has to be taken to recover your money. Every delay is a loss which gets multiplied when expenses to adopt this remedy gets added. Fixed deposits are deposits meant to be paid on demand and any late payment is a breach of contract. When our bank deposits mature we are immune from such possibilities. 

Compliances for the companies    
Many depositors may not know that in terms of the New Companies Act 2013, companies are mandated to obtain ratings from a credit rating agency before accepting public deposits. The total issuance of debt is also to be linked to their net worth and profitability.

Since the ratings are to be made public, depositors should check the soundness of the ratings before taking a decision to invest. Ratings of the fixed deposit schemes should be at least be AA and above, if they are to be considered. Company fixed deposit schemes do not have the benefit of deposit insurance schemes which may protect your investments and the RBI does not guarantee any payment.

Depositors are to make a conscious and calculated decision if they adopt this category of deposits keeping all factors in mind. Corpus of investible funds takes years to be built and hence should be fully protected. You must guard against the temptation of going for higher interest rates and do not get carried away by the marketing people who work on commissions.

Bank fixed deposits and the small savings schemes of post offices score highly on safety and liquidity. They are always a better bet for those who cannot risk losing their savings. It is because banks are in the business of accepting deposits. So why look elsewhere.

(The writer is a banking consultant)

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(Published 22 January 2017, 17:22 IST)

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