Exploring the Benefits and Risks of Floating Rate Savings Bonds

Whenever we require assistance, especially in terms of money, we often turn towards our friends, family, or parents for assistance. Similarly, when the government needs funds for its various projects, it approaches the Apex Bank of India, aka the Reserve Bank of India, to raise money from the general public.

The Indian Government has projected a gross market borrowing of ₹15.43 lakh crore for FY 2023–24 in the Union budget.

So, the government of India borrows money from the general public to fund its projects and issues bonds against them, providing a guaranteed percentage of interest. The RBI carries out this task on behalf of the Indian Government. Let’s delve deeper to understand how these bonds work.

What are Floating-Rate Savings Bonds?

Floating-rate savings bonds are a special kind of debt instrument that provides investors with income and protection against fluctuating interest rates. The term “floating rate” means an interest rate that changes periodically. They differ from “fixed-rate bonds” in regard to the interest rate. Fixed-rate bonds uphold a fixed interest rate, whereas floating-rate bonds represent a recurring change in the interest rate.

The Reserve Bank of India issues these bonds, making them much safer and secure for investment. The interest rate provided by RBI’s Floating Rate Savings Bonds (FRSB) is directly linked to the interest rates of the National Savings Certificate (NSC). The interest provided on a floating rate savings bond will always be higher than the interest on a national savings certificate by 35 base points, i.e. 0.35%. These bonds fall under low risk investment options provided by the Government of India and are thus suitable for risk averse investors.

The interest payable under this savings scheme is half-yearly. The interest rate set for the current half-yearly period is 8.05%. The interest payable for the next half year gets reset every 1st January and 1st July.
The minimum investment one can make under this scheme is Rs. 1000 or more (in multiples thereof). There is no maximum amount to invest under this scheme.

Features of Floating Rate Savings Bonds

• Interest Rate: The interest rate offered on the RBI’s Floating Rate Savings Bond is 8.05% until December 2023.
• Government Securities: As the RBI issues floating-rate savings bonds, they can be considered safe and government-approved securities. This makes them a low-risk investment option for investors.
• Risk: The risk involved in RBI’s FRSB is negligible. One can partially ignore the risk factor while deciding to buy these savings bonds. The only risk one may have an issue with is low liquidity. The presence of a seven year lock-in period makes it difficult for investors to withdraw their capital prematurely.
• Tradability: RBI’s Floating Rate Savings Bonds do not offer trade facilities to investors. They are neither tradable nor transferable.
• Linked to NSC: The interest rate offered on FRSB is related to the rate offered by the National Savings Certificate (NSC). Floating-rate savings bonds will always pay 0.35% higher compared to the NSC rate.
• Maturity: The maturity period of FRSB is 7 years. Only Senior citizens are eligible for premature withdrawal.

There’s a different lock-in period for senior citizens who fall under the following age brackets:

• Interest rate change: The floating interest rate of savings bonds is reset every six months, in January and July of each year.
• Taxation: The interest received on these bonds is taxable. TDS is deducted at the source when interest is paid.

Floating-Rate vs. Fixed-Rate Bonds

Floating-rate bonds, also known as adjustable-rate bonds, offer different interest rates over time. Unlike floating-rate bonds, fixed-rate bonds offer a consistent interest rate throughout their entire maturity tenure.

Investors who are not willing to expose themselves to risky investments prefer fixed-rate bonds. Their risk appetite is low; hence, they prefer low yet secure returns.

Investors who are interested in higher yields in a rising interest-rate environment prefer floating-rate bonds. They can potentially benefit from increasing interest rates; thus, they hold higher risks.

Let’s take a small example to clarify this:

Suppose you bought a fixed-rate savings bond in January 2023, and the interest rate was 7.25%. Later, in February 2023, the RBI made some changes to its monetary policy, and the interest rate was hiked by 0.25%. Because it is a Fixed-rate savings bond, you will not be able to leverage this monetary change. You’ll receive the same interest rate until the maturity of your bond. This is not the case with floating-rate bonds, making them a better return-yielding investment option than fixed-rate bonds.

An interesting fact is, the Government of India decided to launch a Floating Rate Savings scheme (taxable) with effect from July 1, 2020. The first reset on the interest rate occurred on January 1, 2021, when the prevailing NSC rate was 6.8%.

Later, the RBI announced another change in its monetary policy and hiked the interest rate by 0.19%, indicating an upward trend in the interest rate. If you had invested in a floating-rate savings bond, you would be enjoying greater returns compared to those invested in a fixed-rate savings bond. The yields on FRSB adjust to changes in market interest rates.

While floating-rate savings bonds offer greater flexibility, they also come with associated risks. If the interest rate falls, the rate of interest in the FRSB also declines.

Benefits of Floating-Rate Savings Bonds

By now, you are well acquainted with Floating-rate savings bonds. But, before adding them to your portfolio, knowing both benefits and risks is essential. So, let’s start with the advantages of investing in these bonds:

• Higher yields: Floating-rate savings bonds offer a higher yield compared to fixed-rate savings bonds.
• Nomination: These floating-rate savings bonds come with a nomination facility, allowing your nominee to manage your investment after your unfortunate demise.
• Inflation protection: Floating-rate bonds provide protection from inflation as interest rates adjust according to the market’s prevailing conditions. When inflation is high, interest rates gets increased leading to higher yields for investors.
• Diversification: Floating-rate bonds diversify your portfolio by introducing a different asset class into your investments.

Drawbacks of Floating-Rate Savings Bonds

Now that we have covered the positive aspect of RBI’s floating-rate savings bond, it’s time to catch up on the drawbacks associated with it.

• Collateral facility: There’s no collateral facility available with these bonds. That means the bonds are not considered as a support for taking loans from banks or other financial institutions.
• Non-transferable: These bonds are non-transferable in the debt market or any other market.
• Dependent: The Floating-Rate Savings Bonds are dependent upon NSC interest rates. If NSC offers a higher interest rate, the rate of FRSB goes up. Similarly, if NSC’s interest rate declines, FRSB will also lower its interest rate.
• Premature withdrawal: The premature withdrawal encashment of bonds will be available after 4, 5, or 6 years from the investment date. This facility is available for certain investors, not everyone. Hence, it is unsuitable for investors who prefer instant liquidity over a short period of time.

How Do I Buy These Bonds?

The specified banks mentioned below, or the Stock Holding Corporation of India (SHCI), can sell bonds issued by the Reserve Bank of India:

• State Bank of India
• Canara Bank (including Syndicate Bank)
• Union Bank of India (including Andhra Bank and Corporation Bank)
• Axis Bank Ltd.
• ICICI Bank Ltd
• Indian Overseas Bank and more.

If an investor wants to buy these bonds online, here’s the procedure:

• Login to any of the listed bank’s net banking facilities or visit RBI’s Retail Direct Online Portal.
• Click the drop-down menu and select “Transact”.
• Look for the Invest in RBI Bonds’ tab and press ENTER.
• Fill in all the required details, including your personal and investment details.
• Upload the required documents, such as your Address proof, PAN card, a scanned copy of cancelled cheque, and more.
• Go through the terms and conditions section (read them carefully) and approve them using the OTP you received.
• Pay the investment amount using UPI, Net Banking, IMPS, NEFT, or any of the other mentioned gateways.
• Click on “Continue” and Submit the form.
• After your KYC verification and successful submission, you’ll receive a physical certificate as a bondholder from RBI.
•  The bond will be held in dematerialised form in the BLA (Bond Ledger Account) with the RBI or agency bank.

In case you prefer applying for the same in offline mode, here’s what you need to do:

• Visit the physical branch of any of the above-listed banks of SCHI.
• Ask for the RBI Bond Application form.
• Fill out the required details, such as your bank and investment details.
• Attach necessary KYC documents with it.
• Pay the investment amount using cash, cheque, or electronic mode.
• Submit the form.
• After your KYC verification and successful submission, you’ll receive a physical certificate as a bondholder from RBI.
• The bond will be held in dematerialised form in the BLA (Bond Ledger Account) with the RBI or agency bank.

The Bottom Line

Those seeking a low-risk investment option with the potential for some variable returns may find floating-rate savings bonds to be a good choice. The interest rate on these bonds can change over time based on changes in the National Savings Certificate (NSC) benchmark rate.

However, the variable interest rates may not sound good at times when interest rates decline, subsequently decreasing the returns on these bonds. Given all the pros and cons of these bonds, I hope this information helps you make an informed decision.