Understanding Bearer bonds and their functioning in the modern landscape

Bearer bonds have always carried an air of mystique and intrigue. These unique financial instruments, known for their anonymity and ease of transfer, have a rich history spanning centuries. However, in the modern landscape, bearer bonds have become a rarity, with many countries imposing strict regulations or banning their issuance altogether. 

In this blog post, we will delve into the world of bearer bonds, exploring what they are, whether they exist in India, and examining the pros and cons of these instruments.

What are bearer bonds?

Bearer bonds, sometimes referred to as “bearer instruments,” are debt securities in which the ownership of the bond is not registered in the name of the holder. Instead, whoever physically possesses the physical document is considered the owner of the bond. 

One of the distinguishing features of bearer bonds is their anonymity. Unlike registered bonds, where ownership details are recorded in a central registry, bearer bonds lack an owner’s name on the certificate, providing a level of privacy and discretion for the bondholder. When the bond matures, the holder is entitled to receive the face value of the bond, also known as the principal, along with any accrued interest.

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Do bearer bonds exist in India?

In India, the issuance of bearer bonds was once relatively common, particularly in the form of government savings bonds. These instruments offered investors a combination of security and anonymity. 

Electoral bonds are a form of interest-free bearer bonds or money instruments that exist in India. They can be purchased by companies or individuals in India only from SBI (State bank of India). Electoral bonds can be bought through a KYC-compliant account to make donations to political parties, which ought to encash in a given time. 

Example of a Bearer Bond

Let us use a straightforward example to explain how bearer bonds function. Consider the following scenario:

You acquire a ₹10,00,000 bearer bond issued by ABC Enterprises on January 1, 2020.

The bond has a tenure of 10 years, with its maturity date set for January 1, 2030. It carries an annual coupon rate of 6.00%.

Coupon payments are to be disbursed quarterly on January 1, April 1, July 1, and October 1, with the first payment due on April 1, 2020.

With the details provided, you can anticipate the following quarterly coupon payment:

Coupon Pay = Bond Face Value × Coupon Rate ÷ coupon payments/year 

Coupon = ₹10,00,000 × 6.0% ÷ 4 = ₹15,000

Annually, this translates to ₹60,000 in interest income. If you hold the bond until it matures, you can expect to receive ₹6,00,000 in interest payments over the 10-year duration, in addition to the return of your initial ₹10,00,000 investment on January 1, 2030.

A question that is often asked is, “Do bearer bonds expire?” The answer is a simple “yes”, just like we saw in the example above. 

You must detach each coupon and present it to the issuer or their registered agent on or after each designated payment date. Similarly, to redeem the bond, you must submit the bond certificate to the issuer or their registered agent upon maturity.

Also read: Government bonds in India – Meaning, types and features

Pros of bearer bonds

While bearer bonds have declined significantly worldwide, they still possess certain advantages that may make them appealing to some investors or issuers, depending on the jurisdiction. Lets look at the pros associated with bearer bonds:

Anonymity

Bearer bonds provide a high level of privacy and anonymity to bondholders, as there is no centralised record of ownership. This anonymity is attractive to individuals who value financial discretion.

Portability

Bearer bonds are physical certificates, which means they can be easily transported and stored without the need for digital access or electronic records.

No registration hassles

Unlike registered bonds, bearer bonds do not involve complex registration processes. Holders of bearer bonds do not need to provide personal information or have accounts with financial institutions.

Easy transferability 

Bearer bonds are known for their simplicity in terms of ownership transfer. They can be transferred from one person to another by simply handing over the physical certificate, making them highly liquid instruments.

Potential for higher yields

Due to their declining use, some bearer bonds may offer higher yields compared to registered bonds with similar maturities and credit quality.

Also read:What are inflation-indexed bonds, and why should you care?

Cons of bearer bonds 

While bearer bonds offer certain advantages, they also have several drawbacks and challenges that have contributed to their decreasing popularity:

Loss and theft

Bearer bonds are susceptible to loss or theft, and recovering them can be challenging without proper documentation. Losing a bearer bond means losing the associated funds.

Counterfeiting

Bearer bonds can be vulnerable to counterfeiting. It can result in significant financial losses for investors.

Limited liquidity

Bearer bonds may have limited liquidity in the secondary market. Finding a buyer can be more challenging compared to electronically traded securities.

Regulatory scrutiny

Bearer bonds have attracted regulatory scrutiny due to their potential for misuse in activities such as tax evasion and money laundering. Many countries have imposed strict regulations or even banned the issuance of new bearer bonds.

Declining acceptance

Bearer bonds are no longer widely accepted as a means of payment in day to day transactions. Their utility has diminished in the modern financial world.

Conclusion

Bearer bonds, once a significant part of the financial landscape, have faded into relative obscurity in many countries, including India. While they offer unique advantages like anonymity and ease of transferability, these benefits are outweighed by the risks associated with loss, theft, counterfeiting, and regulatory scrutiny.

In India, regulatory measures have largely restricted the issuance and circulation of bearer bonds, aligning with global efforts to combat financial crimes. As a result, individuals and investors are encouraged to explore alternative investment options that offer transparency, security, and compliance with prevailing financial regulations.