A good number of investors prefer bank bonds to park their money. There are valid reasons for choosing bank bonds. Here are some of the reasons.
Returns from the bond investments are higher than Fixed Deposit returns.
During the year 1987, the FD rates were around 10%, and it was about 13% during the early 1990s. Hence FDs were lucrative. The present FD rate is approximately 5.6% (for a duration between 1 year to 10 years). Refer to the Figure below.
The Bond Interest Rates are higher than the Fixed Deposit Interest Rates offered by the same bank.
Tenure: More than three years of investment As on date: 05/06/2020
Entity: State Bank of India
FD Rate 5.30% Maturity 5 years availed.
SBI Bond Paper ISIN INE062A08223 FaceValue 10,00,000 Coupon Rate 8.50% Maturity: 2024 ( 5 years residual maturity left from the date of writing this article )
Total Interest earned by the end of each year (from the time of investment)
Investor earns the following amount more in Bonds = (10,00,000+4,25,000 – 10, 73,780) – (10,00,000+ 2,94,619 – 10,00,000) = 56,601
Also, note that for Bond, the interest payments get credited to the investor’s bank account religiously every year till maturity. So its actual cash flow that the investor enjoys from his Bond investment. If he wants, he can reinvest this amount to earn even higher returns.
For FD, there is not an actual cash flow. Investor’s money is locked till maturity. For FD with a special scheme that pays out annually, the effective returns are even lower.
Note: ADDITIONAL TIER I BONDS (AT1 BONDS)
Tier I Bonds also called Perpetual Bonds. It is a popular option among Banks to raise capital to meet their core capital (Tier1 capital) needs as instructed by RBI. This category carries considerable risk and hence pays high-interest rates to investors. To know more, visit our Bond Glossary.
Why are FD rates low?
FD rates are lower than bond interest rates. Banks have to maintain CRR(Cash Reserve Ratio) as per regulations laid down by the central bank. The banks have to reserve a portion of capital received via FDs; entire capital can not be lent out. This reserved capital can be utilized to supply closures (or pre-closures) in FD. Such constraints are not there on banks on the capital that is raised via bonds. Hence bond rates are higher than FD rates. Refer to the figure(above). With each one of these banks, you can see bond rates are higher than FD rates.
Bonds are tradable; hence you can sell when interest rates increase, resulting in capital gain. FDs are not tradable, and they come with fixed lockin. The investor has to pay the penalty on premature closure of FD. Both FD and bonds fall into the category of low-risk securities.
Banks assure safety for your investments:
The banking sector is a strictly regulated and well-governed system. The Banking Regulation Act, 1949, governs banks in India. And Reserve Bank of India Act, 1934, makes a strict framework of rules, regulations, and guidelines for banks. BASEL-3 norms strengthen the banking system. Basel-3 norms are the global regulatory framework to manage capital adequacy, financial stress, and market discipline. Above all Foreign Exchange Management Act, 1999, regulates bank’s cross border transactions. Banks are not only well-governed, but they are backed by the government, making them sustainable. Investing with banks is always encouraging.
Liquidity of bank bonds
Banks facilitate savings and investments and lend money to businesses and individuals to bring cashflow into the financial system. Banks need a large amount of capital so that banks can maintain liquidity. One of the ways how banks raise capital is via bonds. Hence bank bonds are available most of the time where you can invest and earn the benefits.
There is a proper equilibrium between supply and demand of bank bonds that adds liquidity to bank bonds.
In the worst situation, if a bank is non-performing, a weaker bank will merge with a stronger bank as banks are too big to fail. These were the few reasons why investors prefer bank bonds.
Here is the list of Bank Bonds currently available on our investment platform.