New RBI Bond vs Bank FD: Which investment option is better for you?

Any rise in interest rate will put the Bond in a superior position, while a rate cut would make things worse for an investor in comparison to FD.

Earlier, by looking at the interest rate and tenure of investment, one would have been able to judge if a Fixed Deposit (FD) offered by a bank would give higher return or the Bond offered by the Reserve Bank of India (RBI), and it was relatively simpler to opt for the better investment option, provided the financial health of the institution offering the FD was very strong.

However, it’s not as simple now, as the new series of floating-rate Bonds issued by the RBI will have interest rate risks with the rate of interest to be reviewed in every six months.

“The new Floating Rate Savings Bond 2020(Taxable) or FRSB 2020T from the RBI is aimed at those seeking higher returns on their fixed income investments along with the highest form of capital protection. The interest rate of FSRB 2020T would be reset every six months, with a 35bps spread over the prevailing rate NSC rate. Being issued by the RBI on behalf of the Government of India, these bonds come with sovereign guarantee,” said Sahil Arora – Director and Group Head, Investments, Paisabazaar.com.

So, the equations would completely reverse if the RBI revises interest rate in a positive or negative way – any rise in the rate will put the Bond in a superior position, while a rate cut would make things worse for an investor in comparison to FD.

“The floating nature of FRSB 2020T interest rate will ensure that its bondholders will benefit from the rising rate regime. This gives it an edge over bank FDs, wherein their booked interest rates remain constant during their entire tenure. However, the opposite will hold true during a falling interest rate regime,” said Arora.

Mentioning some drawbacks of the RBI Bonds, Arora said, “A long tenure of 7 years, lack of premature withdrawal facility (except for senior citizens with high penal rates) and the absence of any cumulative option are some of the major drawbacks of the FRSB 2020T.”

So, keeping in view the above drawbacks, Arora further said, “Instead, those looking for higher returns from their fixed income investments with full capital protection can consider fixed deposits offered by some of the small finance banks. Their highest FD slab rates are around 200-300 bps higher than those offered by PSU banks and large private sector banks. Like most bank FDs, those offered by small finance banks too allow premature withdrawal subject to penal rates.”

Talking on safety of the principal invested, Arora said, “Having fixed deposits with these small finance banks is as safe as having FDs with PSU and large private sectors banks. These small finance banks have been categorised as Scheduled Banks by the RBI, which brings their depositors under the cover of deposit insurance program from DICGC, an RBI subsidiary. This insurance program covers bank deposits, including fixed, savings, current and recurring, of up to Rs 5 lakh per customer per bank in case of bank failures.”

“To ensure capital protection of FDs to the maximum possible extent, bank depositors can spread their fixed deposits across multiple small finance banks offering higher FD rates in such a way that the cumulative deposits in each of those banks do not exceed Rs 5 lakh,” he added.