Bank fixed deposits are a better bet than debentures

Standard Chartered Bank’s alleged sale of debentures to its private banking clients with an illegal buyback option has put the spotlight on debentures.

Issuing debentures is one way by which companies raise loans for themselves. Although the money raised by it becomes a part of the company’s capital structure, it does not become share capital. Those who buy debentures are repaid the amount, along with an interest.

Typically, when the capital markets are down and companies find it difficult to raise cash from the equity markets, they would tap alternate sources such as debentures and corporate bonds.

Companies find it cheaper to issue debentures, since it does not require any registration cost, like bonds do. There are different types of debentures, including non convertible debentures (NCD), partly convertible debentures, fully convertible debentures and optionally convertible debentures.

Typically, debentures come with some guarantee — either on returns, both on the lower and higher side, or of capital/principal protection. Standard Chartered Bank officials had promised to buyback the debentures from its wealth management customers.

Like bonds, debentures come with ratings by credit rating agencies. Mostly, higher the rating, better the company and safer the investment.

But the safety might lead to capped returns. So, riskier the company, higher the interest it would offer investors. For instance, last year saw some realty companies offering as much as 18-20 per cent for their NCDs. Investment experts, and even the Reserve Bank of India, have been raising doubts about sound financials of the realty sector.

Some debentures are stock market-linked and are generally issued by banks and portfolio managers, like a Nifty-linked debenture. Most portfolio management services’ managers offer the product to their clients.

Most investors in this avenue are high net worth individuals. This product is not advised for retail investors because it is more risky and retail investors may not understand the product. Also, debentures are highly illiquid with one’s investment being blocked until the term ends.

Debentures are safer than corporate bonds, but less safe than a bank fixed deposit (FD). Also, here you are taking a bet on one company and the risk of default remains. For retail investors, FD is a better bet in the current high interest rate regime, where banks are giving up to 10 per cent on one-year FDs. Therefore, do not get lured by high rates on debentures.