One of the important sources of finance to trading and manufacturing companies in India has been public deposits. Generally companies opt for this method of financing rather than debenture or debt financing since they offer attractive rates of interest.
Investors show more interest in public deposits rather than depositing their funds in commercial banks as borrowing from banks requires strict compliance of certain conditions and formalities etc. Sufficient securities should also be offered. The rate of interest is also high. These complications are not there in case of public deposits.
Advantages of Public Deposits
Companies find the public deposits as an attractive source for medium and short-term finances. This is due to following advantages:
1. Lower Rate of Interest
Public deposits are beneficial to the company as it receives funds at a lower rate of interest when compared to the rates charged by commercial banks and financial institutions.
2. Low Administration Costs
Cost of administering public deposits is lower when compared to the issue of debentures. The company has to fulfill fewer formalities and follow a simple procedure. It receives money and issues only a deposit receipt to every depositor and nothing more.
3. Facilitates trading on Equity
Public deposits help in trading on equity if the company is earning more than the rate of interest paid on the deposits. The excess profit shall go to the equity holders. At the same time, their control over the company is also not diluted.
Public deposits are generally unsecured. The company need not create any charge over its assets. Hence, its borrowing capacity is not affected.
Public deposits facilitates flexibility in the financial planning. The deposits can be paid back any time, when there is no further need for retaining the fund. Thus, it is a convenient method to avoid over capitalization.
Disadvantages of Public Deposits
Though public deposits constitute an attractive source of finance and the investors do prefer them, there are certain severe limitations and dangers. Some of the dangers associated with this practice are given below:
1. Unreliable Source
This method is not reliable because it is difficult to predict whether the company can procure such deposits to the desired level. Such deposits are termed “Fair weather friend” The depositors may not respond favorably when the conditions of the company are not satisfactory. Similarly, new companies cannot depend on this source of finance.
2. Interest of the Investors
The interest of the depositors is not fully protected. These depositors are unsecured and no charge is created over the assets of company. Moreover, the management very often uses these funds for non-productive purposes. In the event of failure of the company, the depositors have no assurance of getting their money back.
3. Threat to Bank Resources
An uncontrollable growth of company deposits should be viewed with great concern. It diverts the bank resources to the non-banking sector. It also poses a threat not only to bank deposits but also to the credit planning and effective monetary policy.
In fact, the RBI has substantially failed to implement its general policy of credit restraint and enforcement of selective credit control only due to the sudden spurt of the company deposits.
4. Distortion of Plan Priorities
These deposits even distort the plan priorities for credit allocation and blunt the edge of monetary policy specially the dear money policy. They frustrate even the very object of reducing the sectoral and regional imbalances and also develop disparities between sectors and regions.
5. Unhealthy Trend in the Capital Market
Such deposits also create unhealthy trends in the capital market. There are numerous rates of interest offered by different companies. This is detrimental to the development of the capital market.