A bank debenture is a financial instrument issued by a bank to investors as a means of raising capital. The bank that issues a debenture agrees to make regular interest payments to the investor on what is essentially a loan from investor to the bank. At the conclusion of the term of the bank debenture, the bank returns the principal of the loan to the investor along with any remaining interest. Unlike a bond, a debenture is not secured by any specific collateral that the investor can claim upon default.
Even the largest financial institutions may need capital at some point to fund some sort of growth or new initiative. This funding may come on the highest level from other institutions and be far out of the reach of normal investors. On occasion, though, banks trying to raise money will reach out to average investors with long-term acknowledgments of debt that may be purchased on the open market. An investor who buys a bank debenture buys into this debt.
There are many similarities between a bank debenture and a bond, in that they both are debt instruments in which an average investor gives a loan to an institution and receives return of the principal plus interest payments. The main difference comes from the fact that debentures generally offer no collateral to the investor. This means that there is no guarantee to the investor upon purchasing the debenture that his investment capital may be returned to him.
In return for taking on this extra risk, the investor is generally pledged a higher rate of interest on a bank debenture than she would get from a bond. These interest payments are generally made by the bank throughout the life of the debenture agreement. If the investor finds a reliable bank to issue a debenture, the investment can be a safe way to generate significant returns. Unfortunately, scams have been associated with bank debentures in the past, so investors must do the proper research before proceeding.
For a bank, the advantage to a debenture compared with a bond is that the money owed to the investors is not tied down, meaning that the bank can use it to generate more funding. Should a bank default on its debenture obligations, investors holding the debt would have no claim on any of the bank's assets. In this case, the person holding a bank debenture would stand along with all other common investors and receive repayment only after the assets that are claimed by other organizations have been doled out.
