The Floating Rate Savings Bond 2020 is one of India's most popular retail government bonds in India.

The interest rate on this bond was increased from 7.15% to 7.35% from January 1, 2023, making headlines at the start of the new calendar year.

These government floating rate bonds are well known in the retail investor segment as the "RBI 7.35% Bonds," as they currently offer a 7.35% taxable interest rate over a tenure of seven years. (RBI is the administrator, not the issuer).

Retail investors can invest up to ₹20,000 in cash, and the minimum subscription amount is ₹1,000 for these bonds.

These Floating Rate Savings Bonds can be purchased through the branches of SBI, nationalised banks, or four private sector banks: HDFC Bank, ICICI Bank, Axis Bank, and IDBI Bank.

These bonds were first issued in 2020 to replace the Government of India's 7.75% (taxable) bonds. The interest rate on these bonds is set every six months at a spread of 35 basis points over the prevailing national savings certificate, which is currently at 7.00%.

The Floating Rate Savings Bond 2020 is taxable, can't be given to someone else, and can't be used as security for loans or anything else.

What Exactly Are Floating Rate Bonds?

Floating Rate Bonds are debt securities that give higher interest rates when interest rates increase, rather than fixed-coupon bonds, which offer the same interest rate during the life of the bond.

The Floating Rate Bond interest rate paid to investors is linked to an underlying specific benchmark rate.The coupon rate is generally linked to Treasury bills, MIBOR, Repo Rate, or inflation rate.These floating rate bonds are also referred to as "floaters."

The government, financial institutions, and companies with short- to medium-term maturities in India have issued floating-rate bonds.At the end of the term of these bonds, the issuer pays back the principal amount that was raised initially.

The rest of the interest rates on FRBs could be determined quarterly, semi-annually, or annually, as decided by the issuer during the issuance of these securities.

FRBs trade near their face value in the secondary market as interest rate resets happen at regular intervals.

For example, if company XYZ issues 3-year floating rate bonds on Jan 1, 2023, the coupon may be 50 basis points or 0.50% above the 182-day Treasury Bills (T-Bills) revised every six months. XYZ company will take the prevalent current yield of the 182-day T-bill on Dec 31, 2022, and will offer 7.55% (7.05% + 0.50%) as an interest rate from Jan 1st to Jun 30th, 2023. XYZ Company will change the interest rate on Jul 1st based on the 182-day T-Bill yield offered on Jun 30th, 2023.

An issuer can also have a callable option with floating rate bonds specified during these bonds' issuance. A company may have a call option if there is a considerable rise in the interest rates linked to the benchmark securities and the cost of borrowing rises significantly.

Issuance of FRBs in India so far

The government of India issued its first floating rate bonds in September 1995. Since then, it has issued FRBs linked with the 182-day T-bill rate and pays a variable coupon rate every six months at pre-announced intervals.

The RBI also issued a couple of inflation-indexed bonds (IIBs), a type of floating rate bond, in 2013. One of the IIBs was linked with the wholesale price index, and the other was linked with the consumer price index, issued exclusively for retail investors. These inflation-linked bonds did not find wider acceptance; hence they were discontinued.

Despite a lacklustre response from institutional investors, the Government of India is the largest issuer of FRBs, with six outstanding floating-rate securities valued at $4.58 trillion as of February 13, 2023.

A recent issuance of Floating Rate Saving Bonds in 2020 by the RBI for individual and HUFs (Hindu Undivided Family) investors has gained momentum as retail investors look for avenues to protect their savings and get an interest rate that may beat the ever-rising inflation in India.

Companies and financial institutions have also kept pace with floating rate bond issuance in India, with 3,794 outstanding instruments worth ₹2.43 trillion as of Dec 31, 2022, as per SEBI data.

Benefits & Risks of FRBs

Floaters allow investors to protect themselves from rising interest rates, as the FRB's rate generally adjusts to market conditions.

The government offering FRBs is considered a safe investment option for investors as the sovereign entity is considered credit-risk free.

FRBs are less volatile as the price of these bonds hovers closer to their face value, and the coupon is reset at regular intervals depending on the benchmark securities linked to them.

FRBs protect investors to some extent from interest rate risks when interest rates are going up because the interest rates are changed periodically to match the rates that are in effect at certain times.

Although these bonds offer the above benefits, certain risk factors must be considered before investing in these securities, such as default risk. If the company that gave out floaters can't pay back the principal, the investor could be at risk of default.

Floaters are beneficial only during rising interest rate scenarios; if the interest rates fall in the market, the coupon interest may also come down. Hence, FRBs do carry interest rate risk too.

Sources: Reserve Bank of India,Securities and Exchange Board of India,Media Reports