Top 2 Categories for Evaluation of Public Deposits

This article throws light upon the top two categories for evaluation of public deposits. The categories are: 1. As a Source of Corporate Finance 2. Investor’s Point of View.

Category # 1. As a Source of Corporate Finance:

Many companies have accepted unsecured deposits from the public in the recent past, in India, mainly to finance their working capital requirements. In fact, public deposits with non-banking joint stock companies have become an important source of finance in India because both the investors and the borrowing companies derive significant advantages from them.

The reasons for increasing demand of public deposits from the corporate sector can be evaluated in terms of cost, availability of alternative sources of finance and the convenience in raising funds.

(i) Cost of Funds:

Although interest rates on public deposits with companies are higher than those on bank deposits, these are certainly lower than the minimum rates charged by banks on advances. The interest rates on public deposits have also been comparatively lower as compared to the interest rates charged by the term lending financial institutions.

Inspite of disadvantage under Income Tax Act, 1961 for non-deductibility of 15 per cent of the expenditure by way of interest paid on public deposits, the effective post tax cost of public deposits has been reasonable compared to the other sources of raising funds.

(ii) Availability of Alternative Sources of Finance:

Various companies particularly the private limited and small companies have not been able to meet fully their financial requirements from bank, term- lending financial institutions and new issues of capital. In fact, there has always been some credit gap for companies in India. Moreover, banks and other financial institutions insist for minimum margin money which may be difficult to arrange.

Even large-scale companies do not want to depend merely on these alternative sources of finance because of stringent RBI policy as regards Tandon Committee Norms and Credit Authorisation Scheme, etc. Thus, companies in India have resorted to accepting direct deposits from the public to meet their requirements of funds.

(iii) Convenience in Raising Funds:

Rising of funds through public deposits is simpler, more convenient and involves lesser formalities. The company has simply to issue an advertisement containing certain details for accepting deposits from the public. Compared to this, rising of funds from banks and other financial institutions is more cumbersome.

Companies, usually, find it more difficult to comply with the formalities of these specialised creditors as regards providing of credit information and meeting their standards. These companies also find difficulties in negotiating favourable terms from them. Moreover, these specialised creditors generally demand security of certain assets in the form of mortgages.

No security is, however, provided on public deposits and hence there is no need of creation of any charge against any of the assets for raising funds through public deposits. Thus, mortgageable assets of the company are conserved and many companies prefer public deposits for raising funds.

We can sum up the advantages of raising funds through public deposits from the company’s point of view as below:

(a) It is a less costly method for raising short and medium term funds for meeting working capital requirements. The post-tax cost of public deposits is also fairly reasonable.

(b) The procedure for raising funds through public deposits is simpler, more convenient and less bothersome.

(c) As there is no need of creation of any charge on the assets of the company for raising funds through public deposits the company’s mortgageable assets are conserved.

(d) A company can take advantage of trading on equity as the maturity period of deposits and the rates of interests are fixed.

(e) A company can avail this source of finance even when other sources of finance are not available to it because of margin money or other Govt. regulations.

In spite of many advantages, the following are the limitations of public deposits from the company’s point of view:

(i) The quantum of funds that can be raised through public deposits is limited to a maximum of 35 percent of paid up capital and free reserves (25 percent from general public and 10 per cent from shareholders, directors, etc.) as per the provisions of the Companies (Acceptance of Deposits) Rules.

(ii) The maturity period of public deposits is very short.

(iii) Raising funds through public deposits is not a reliable and definite source of finance. Only companies enjoying good reputation can attract public deposits.

(iv) The Govt. has restricted the growth of public deposits through imposing ceilings on rates of interest, rates of brokerage and the amounts of deposits.

Category # 2. Investor’s Point of View:

It is not only the company which is benefited from public deposits; the investors also find certain advantages in public deposits. We can evaluate the advantages of public deposits from the investor’s point of view in terms of rates of interest and the maturity period.

(i) Rate of Interest:

The rates of interest payable on public deposits are usually higher than the alternative sources of safer investments such as banks, post offices, etc. In spite of the ceiling on maximum rate of interest, it is still fairly reasonable.

Although, income from interest on public deposits is taxable for the investor and tax is deducted at source if the income exceeds Rs. 1000, it has not reduced the effective rate of return on public deposits in many cases as investors have been avoiding tax on such income due to various loopholes in the system.

(ii) Maturity Period:

Short maturity period of public deposits offers another advantage to the investors.

However, the risk of the investor in public deposits is much higher than investment in bank deposits, post offices, insurance companies, etc.; as no security of asset is offered by companies on public deposits. Further, unlike bank deposits, public deposits are neither covered by any insurance nor are guaranteed by the Govt.

In many cases companies have not paid interest on due dates and even repayment schedule of public deposits has not been honoured.

Many investors do not prefer public deposits because of non-exemption of interest income for income tax purposes. Moreover, public deposits are not as liquid asset as bank deposits. An investor can easily withdraw his deposit from a bank but not from a company.

In addition to these limitations from the investor’s point of view, public deposits, in many cases, encourage non-priority sectors of production and defeat the very purpose of the restrictive credit policy of the Reserve Bank of India.

Inter-Company Deposits:

A deposit made by one company with another company, usually for a period up to six months, is called inter-company deposit.

Such inter-company deposits are usually of three types:

(i) Call deposit,

(ii) Three- month’s deposit, and

(iii) Six-months deposit.

The market for inter-company deposits in India has been expanding particularly since 1973. In the earlier periods, some big companies with huge liquid resources at their command primarily kept to exploit investment opportunities in the form of acquisition and take-over of other companies, invested their liquid funds in the form of call deposits with other companies.

With the restrictions on working capital finances imposed by the Reserve Bank of India in 1973, the demand for such deposits increased considerably. Another important feature of inter-corporate deposits is that while Sec. 58. A of the companies Act, 1956 has imposed limits on borrowings in the form of inter-corporate long-term loans; there is no such restriction on inter-corporate deposits for short-term.