Are corporate fixed deposits safe?

Introduction

People make investments to make money. Risk-averse investors usually gravitate towards bank fixed deposits because of the safety and guaranteed returns. Interest rates offered are low despite a surge in the inflation rate. If high inflation persists, interest rates may go up, but still these FDs may not be able to beat inflation with their returns.

Keeping this situation in mind, many investors have started considering corporate fixed deposits as an alternative. Corporate FDs provide higher interest rates compared to bank FDs. However, the risk that they carry is also higher. Let's understand this in more detail.

What are corporate FDs?

Companies issue corporate FDs looking to raise money. Bank FDs are backed by the overall assets that they manage, which is usually a large volume. In addition, the Deposit Insurance and Credit Guarantee Corporation guarantees up to Rs. 5,00,000 per investor in a bank. That means that investors can recover at least this amount in case of a default. However, corporate FDs could be unsecured instruments. It means these deposits do not have collateral or an asset to guarantee the return.

Additional read: All you need to know about Corporate fixed deposits

The risks associated with corporate fixed deposits

All corporate FDs must adhere to strict regulations laid down by the Reserve Bank of India and the Ministry of Corporate Affairs. That means that all companies are not eligible to issue corporate FDs. Companies must have a minimum credit rating ,as defined by RBI, from a qualified credit rating company to issue corporate FDs. The minimum credit rating defined by RBI for major credit rating agencies are follows:

Despite these ratings, corporate FDs are not risk-free. For one, there is a possibility that the company's financial condition deteriorates, and therefore, the FDs become prone to default risk. At other times, credit rating agencies may not be able to detect the ill-health of a company in the longer duration. Take the case of Dewan Housing Finance Ltd., for instance. Despite being highly rated, the company defaulted on its corporate FDs. It even went on to face bankruptcy proceedings. It is advisable to invest in high credit rating FDs to avoid default risk. However, companies with a higher credit rating may offer you a slightly lower return than low credit-rated companies.

These are some of the risks you need to know before investing in corporate FDs.

Should you invest in corporate FDs?

If you have a moderate to high-risk appetite, then your portfolio can benefit from corporate FDs in it. However, make sure that you take the following precautions:

• Don't go by the credit rating of the company alone. Do a check of the company's financials on your own to ensure it is in good health. 
• Choose a company that has been making profits for at least three consecutive years. 
• Many start-ups in the market may be keen to raise funds. Picking a company that has been around for at least five years is a fair game. 
• Don't fall prey to companies promising high returns. Always carry out a risk-reward analysis before choosing which company to invest in. 
• Diversify your investment among different corporate FDs to diversify your risk and invest a limited amount in corporate FDs.

Conclusion 

All investments carry a certain amount of risk. Corporate FDs come with their fair share of risks. However, the returns that they provide are also higher. So if you do wish to invest in corporate FDs, make sure you do your due diligence and choose a reliable company, even if it means you compromise on the interest rate to an extent.

Disclaimer: ICICI Securities Ltd.( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470.  I-Sec is acting as a distributor to solicit bond related products. All disputes with respect to the distribution activity, would not have access to Exchange investor redressal forum or Arbitration mechanism. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.