From the company’s point of view, public deposits are a major source of finance to meet the working capital needs. Due to the credit squeeze imposed by the Reserve Bank of India on bank loans to the corporate sector during 1970s – 1980s and also due to the recommendations of the Tandon Committee, restricting credit, many companies were not getting as much money in the 1980s as they used to get, in the past, from the banks. So, public deposits came handy as working capital fund for businesses. While to the depositor, the interest rate offered is higher than that offered by banks, the cost of deposits to the company is less than the cost of borrowings from bank. Moreover, the availability and volume of bank credit are restricted by consideration of margin, security offered, periodical submission of statements etc. The credit available to companies through public deposits is not affected by such consideration. There is no problem of margin or security. Since the fixed deposits from the public are unsecured, the borrowing company need not mortgage or hypothecate any of its assets to raise loans in this form. These deposits are available for comparatively longer terms than bank credit.
Merits of Public deposits
The merits of public deposits are as follows:
- There is no need of creation of any charge against any of the assets of the company for raising funds through public deposits.
- The company can get advantage of trading on equity since the rate of interest and the period for which the public deposits have been accepted are fixed.
- Public deposit is a less costly method for raising short-term as well as medium-term funds required by the companies, because of less restrictive covenants governing this as against bank credits.
- No questions are asked about the uses of public deposits.
- Tax leverage is available as interest on public deposits is a charge on revenue.
Demerits of public deposits
The main demerits of the public deposits are as follows:
- This mode of financing, sometimes, puts the company into serious financial difficulties. Even a slight rumor about the inefficiency of the company may result in a rush of the public to the company for getting premature payments of the deposits made by them.
- Easy availability of fund encourages lavish spending.
- Public deposits are unsecured deposits and in the event of a failure of the company, depositors have no assurance of getting their money back.
RBI Regulations for Public Deposit
The RBI regulation of public deposits has six main aspects:
- There is a ceiling on the quantum of deposits in terms of paid-up capital and reserves by the company because undue accumulation of short-term liabilities in the form of deposits can lead a company into financial difficulties. In the beginning the definition of deposits was quite narrow and excluded unsecured loans accepted from the public and guaranteed by the directors. Now the term deposit covers “any money received by a non-banking company by way of deposit or loan or in any other form but excludes money raised by way of share capital or contributed as capital by proprietors”.
- The second aspect of the Reserve Bank’s regulation is the limit on the period of such deposit. Formerly, in order to avoid direct competition with short-term public deposits, companies were prohibited from accepting deposits for a period of less than 12 months. But the 1973 amendment reduced the period to less than 6 months. The short-term deposit is now pegged down to 10 per cent of the aggregate of the paid-up capital and free reserves of the company while secured and unsecured deposits shall not exceed 15 per cent and 25 per cent, respectively, of the paid-up capital and free reserves.
- The Reserve Bank has made obligatory on the part of the companies accepting deposits to regularly file returns, giving detailed information about them, their repayment, etc. so that the Reserve Bank can verify whether the companies adhere to the restrictions. However such statements are not filed late and the Reserve Bank’s action to prevent a defaulting company from accepting any deposit fails to afford any protection to existing depositors.
- The Reserve Bank has stipulated that while issuing newspaper advertisements (or even the application forms) soliciting such deposits, certain specified information regarding the financial position and the working of the company must accompany. This clause is often misused as much advertisement often carried words like “as per Reserve Bank directive”, thereby giving a wrong impression that these deposits are actually governed by the Reserve Bank. Now such advertisements would be illegal and attract penal provision prescribed in this behalf. Similarly, the catalogs and handouts issued by brokers stating that the companies mentioned therein had complied with Reserve Bank directives would also attract the penal provision.
- The Reserve Bank has entrusted the auditors of the companies with additional responsibilities of reporting to it that the provision under the Act has been strictly followed by the company.
- The Reserve Bank has issued a broad “RBI Directives on Company Deposit” in order to clarify its role in protecting depositors. The bank has reiterated that the deposits or loans are fully protected or are absolutely safe merely because the companies claimed to have complied with the RBI directives and that they should not presume that the Reserve Bank can come to their rescue in the event of failure of a company to meet its obligations.