PUBLIC DEPOSITSPublic DepositsThe public deposits refer to the deposits that are attained by the numerous large and small firms from the public. The public deposits are generally solicited by the firms in order to finance the working capital requirements of the firm. The companies offer interest to the investors over public deposits.The rate of interest, however, varies with the time period of the public deposits. The companies generally offer 8 to 9 percent interest rate on the deposits made for one year.

The companies offer 9 to 10 percent interest rate over public deposits for two years while 10 to 11 percent interest rate is offered for the three year deposits. There are rules regulating the fixed deposits.

Public deposits refer to the unsecured deposits invited by companies from the public mainly to finance working capital needs. A company wishing to invite public deposits makes an advertisement in the newspapers.Besides the issue of shares- equity and preference and debentures, a company can accept deposits from the public to finance its medium and short-term requirements of funds. This source has become very popular recently because, a company offers interest at a rate higher than offered by banks. Under this method, companies are able to obtain funds directly from public without financial intermediaries.

Any member of the public can fill up the prescribed form and deposit the money with the company. The company in return issues a deposit receipt. This receipt is an acknowledgement of debt by the company. The terms and conditions of the deposit are printed on the back of the receipt. The rate of interest on public deposits depends on the period of deposit and reputation of the company.

Meaning of Public Deposits:The practice of accepting public deposits by public companies in India developed during the first quarter of the 20th century when textile mills of Bombay, Ahmedbad and Sholapur and tea gardens of Assam and West Bengal accepted public in banks. Moreover, at that time, there was no public financial institutions to provide medium and long term finance to industries in India. The practice in other industries was not popular. In recent year, the method of raising finance through public deposits has again gained popularly. Now public deposits are accepted by the companies under non-banking companies (Acceptance of deposits) rules. The Government has laid down limits as to interest, acceptance and renewal of deposits from public.Companies accept deposits for varying periods ranging from 6 months to 3 years at rates of interest which are higher than those offered by the commercial banks. The rate of interest varies from 11 percent to 15 percent depending upon the period of deposit and reputation of the company. companies generally take help of financial brokers and other intermediaries in raising funds through public deposits. The company issues a deposit receipt under terms and conditions printed on the back of the deposit receipt.Public deposits are those deposits which are taken from the members or directors of the company or from the general public at a specified rate of interest for a specified period. This method of raising fund is becoming popular at present since the bank credit is becoming costlier. According to the existing provisions, a company cannot accept any public deposit for a period of less than 6 months and more than 36 months.But in order to meet the short-term requirement (i.e., working capital requirements) deposits up to 10% of paid-up capital plus free reserves minus intangible assets, accumulated losses, deferred revenue expenditure, may be accepted for a period of three months.At the same time, on and from 1st April 1979, no company can accept or renew deposits in excess of 35% of its paid-up capital plus free reserves as against the limit of 40% up to 31st March 1979.

According to the Companies Amendment Rules 1978, here is the list of rules for public deposits:

The maximum maturity period for a public deposit is 3 yearsThe minimum maturity period for public deposits is 6 monthsThe maximum maturity period for a public deposit for Non-Banking Financial Corporation is 5 yearsThe public deposits of a company cannot go past 25% of free reserves and share capitalsThe companies asking for public deposits need to publish information regarding the position and financial performance of the firmThe companies having public deposits need to keep aside the 10% of the deposits by 30th April every year that will mature by 31st March next year.

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.

What are public deposits? Why do companies find public deposits attractive?

Public deposits are the source for meeting the working capital needs of the company. Companies find public deposits as attractive source due to the following reasons:1) It is more convenient to borrow funds in the form of public deposits than borrowing the funds from banks and financial institutions.2) Borrowing funds from banks and financial institutions is a tedious job as compared to borrowing funds from public deposits.3) The rate of interest paid on public deposits is less in comparison with other borrowed funds.4) They are unsecured form of borrowing.5) Funds raised from public deposits can be used for any purpose.6) In case of credit squeeze public deposits play very important role.

How is control over Public deposits exercised?

The control over public deposits was exercised by introducing Sec 58A and 58B to the Companies Act, 1956 vide Amendment Act, 1974 and the announcement of Companies rules, 1975 which applies to the non banking finance companies. The main provision of these regulations regarding the applicability of term deposits is as below:

Deposits cover all types of loans and deposits excluding the following:1) Amount received from the government, local authority, and foreign government and any amount whose repayment is guaranteed by the Government.2) Any loans from Banks or Financial Institutions.3) Amount received by a company from another company.4) Security deposits from employees.5) Advance for purchase or sales.6) Amount received for subscribing to shares and debentures pending allotment.7) Amounts received in trust or amounts in transit.8) Amounts received form directors or form shareholders of a Private Limited Company.

What requirements does a company need to comply with before accepting the deposits?

Following are the requirements need to comply with before accepting the deposits:

1) No deposit shall be accepted which is payable on demand.2) A deposit can be accepted for a minimum period of 6 months and maximum period of 36 months.3) The maximum amount of deposits which a company may accept will be 25% of the aggregate of paid up share capital and free reserves out of which not more than 10% should be from a shareholder of non-private limited companies or should be guaranteed by any director.4) The maximum interest which a company can pay on its deposits depends upon the maximum rate of interest prescribed by the Reserve Bank of India.5) The maximum amount of brokerage which a company may pay on deposits accepted will be the following percentage of deposits:- 1 % for deposits upto one year- 1.5% for deposits upto two years.- 2% for deposits upto three years.

How can a company invite public deposits through advertisements? What are the details required to be included in the advertisements?

If a company wants to invite public deposits, it should publish an advertisement in the state in which the registered office of the company is situated. Such advertisement should be issued on the authority and in the name of the Board of Directors of the company and should contain a reference to the date on which the Board of Directors has approved the text of the advertisement. Following details are required to be included in the advertisements:

1) Name of the company2) Date of incorporation of the company3) Business carried on by the company and its subsidiaries with the details of its branches, if any.4) Particulars of management of the company5) Names, addresses and occupations of the Directors.6) Profits before tax and profits after tax, for the 3 financial years immediately preceding the date of advertisement.7) Summarised financial position of the company.8) The amount of deposits which can be rasied by the company and the amount of actual deposits held

by the company on the last day of the immediately preceding financial year.9) A statement showing amount of overdue deposits if any.10)A declaration that the company has complies with the provisions of these rules.11)A declaration that the deposits accepted by the company are on unsecured basis.12)A declaration that the compliance with these rules does not imply that repayment of deposits is guaranteed by the Central Government.

What details does a deposit receipt include?

Following details are included in a deposit receipt:

1) Date of receipt2) Name and address of depositor3) Amount of deposit4) Rate of Interest5) Date of maturity.

Regulation of Public Deposits:It has already been stated above that since 1967 RBI has started to regulate and control public deposits accepted by non-banking companies. The regulations and provisions were introduced in January 1967.These rules and provisions were modified’ revised and made more comprehensive from time to time in order to exercise control over these deposits and. at the same time, offered reasonable protection to the lenders or deposit holders.Again, during I 967, the companies could accept deposits to the extent of 25% of paid-up capital plus free reserves However, from January, 1072, the deposits (in the form of unsecured loans) guaranteed by the directors and the deposits raised from shareholders were also brought under the deposit control scheme.In January 1975 the ceiling of 25% of paid up capital plus free reserves had come down to 15% and again, at recent times, it comes further down to 10% of the said paid-up capital plus free reserves It was operated from 1st April 1979 and consequently the companies brought down their public deposits to the limit of 1st April 1980.Every company shall invest not less than 10% of the amount of its deposits maturing during the year ending on 31st March next following in a current or other account with a scheduled bank free from any charge of lien, or in approved securities.It will ensure the liquidity of public deposits and guaranteed repayment of maturing deposits which cannot be renewed The amount so deposited or invested shall be utilised only for the repayment of deposit maturing during the respective year.If the deposits are accepted in contravention of the limits prescribed by the Central Govt. a mandatory fine which shall not be less than an amount equal to the amount of the defaulting deposit which has already been accepted and at the same time where the contravention is one of inviting deposits in excess of prescribed limits, a fine not less than Rs. 5,000 and not more than Rs 1,00,000 shall be imposed.

Effective Rate of Interest on Public Deposits:The normal rate of interest on public deposits varies from 12% to 16% p.a. in India It is interesting to note that the actual cost of public deposits is more in comparison with the nominal cost This is due to the fact that in case of other long-term or short-term borrowings the entire amount of interest cost is an admissible charge against the revenue while computing taxable profit.But in case of public deposit, maximum limit is fixed at 85% of the total interest cost, i.e. 15% of such interest is actually disallowed which, in other words, increases the real cost of funds.

Therefore, the real cost of funds which are supplied by public deposits may be calculated with the help of the following formula:

We have considered so far only one aspect, i.e., taxation effect. But there are other aspects also For instance, a certain amount is to be incurred on account of brokerage/ advertisement, forms, etc. Moreover, like bank finance, current flow of funds does not reduce the block of liability which conforms till repayment.At the same time, unproductive interest cost on the funds must be set aside and to be held as liquid assets under Rule 3 A of the Companies (Acceptance of Deposits) Rules 1975.As such, after considering all the related factors, the effective cost of public deposits can be computed with the help of the following:

The above financial can be illustrated with the help of the following illustration:Illustration:From the following particulars, compute the effective rate of public deposits:Rate of Interest on public deposits is @ 20%.Number of years is 3.Rate of taxation is 50%.Brokerage @ 1% and Flotation Cost @ ½ %.Solution:

 Thus, the real cost of public deposits may rise to such an amount which exceeds the cost of other types of bank finance, viz., cash-credit, term-loans or overdraft etc.

Merits of Public Deposits / Advantages of Public Deposits:Public deposits offer the following advantages:i. Acquisition of finance through public deposits is very easy.ii. Interest paid on public deposits is tax deductible expenditure.iii. Administrative cost of issuing a public deposit is lower than the cost involved in issuing shares and debentures.iv. Since the rate of interest paid on a public deposit is fixed, it helps the company play trading on equity.v. It does not dilute the control of shareholders.

The various advantages of public deposits enjoyed by the companies are:

There is no involvement of restrictive agreement

The process involved in gaining public deposit is simple and easy

The cost incurred after tax is reasonable

Since there is no need to pledge security for public deposits, the assets of firm that can be

mortgaged can be preserved

As a source of finance, public deposits have the following advantages:I. It is beneficial to the company accepting deposits since it receive finance at a lower rates of interest than charged by the banks and special financial institutions on lending.II. Interest paid on deposits is a deductible expense for income tax purpose.III. Administrative cost of deposits is lower than that involved in issuing shares and debentures. The company has to fulfil lesser formalities in accepting public deposits.IV. As the rate of interest on public deposits is fixed, it helps the company to play trading on equity, if the company is earning more than the rate of interest paid on public deposits.V. Depositors have no interference in the management and control of the affairs of the company as they have no voting rights. Thus, there is no dilution of control of shareholders.VI. Public deposits are not backed by any charge on the assets of the company. The company may accept charge on its assets while raising loans from other sources like banks and financial institutions.VII. Capital structure of the company remains flexible by accepting public deposits. Company can repay the deposits when they are not required by the company.

1. Simplicity:Public deposits are a very convenient source of business finance. No cumbersome legal formalities are involved. The company raising deposits has to simply give an advertisement and issue a receipt to each depositor.

2. Economy:

Interest paid on public deposits is lower than that paid on debentures and bank loans. Moreover, no underwriting commission, brokerage, etc. has to be paid. Interest paid on public deposits is tax deductible which reduces tax liability. Therefore, public deposits are a cheaper source of finance.

3. No Charge on Assets:Public deposits are unsecured and, therefore, do not create any charge or mortgage on the company’s assets. The company can raise loans in future against the security of its assets.

4. Flexibility:Public deposits can be raised during the season to buy raw materials in bulk and for other short-term needs. They can be returned when the need is over. Therefore, public deposits introduce flexibility in the company’s financial structure.

5. Trading on Equity:Interest on public deposits is paid at a fixed rate. This enables a company to declare higher rates of dividend to equity shareholders during periods of good earnings.

6. No Dilution of Control:There is no dilution of shareholders’ control because the depositors have no voting rights.

7. Wide Contacts:Public deposits enable a company to build up contacts with a wider public. These contacts prove helpful in the sale of shares and debentures in future.

Demerits of Public Deposits / The disadvantages of public deposits are:The method of raising funds through public deposits suffers from the following limitations disadvantages:

Public deposits has the following disadvantages:i. They are uncertain and unrealistic forms of financing.ii. The new company finds it difficult to raise public deposites

ii. Public deposits are available for short periods only.iii. The management may misuse the deposit as these deposits are not secured.

The disadvantages of public deposits from the company’s point of view are:The maturity period is short enoughLimited fund can be obtained from the public deposits

I. Public deposits are fair weather friends’. It is an uncertain and unrealistic from of financing. When depositors feel that the company is in a shaky position, they may not respond to fresh deposits or may start withdrawing their existing deposits.II. Public deposits are available mainly for short period. Company cannot depend on this source of finance for its long-term requirements.III. The management may misuse the deposits as such deposits are not secured. Company may use them as it likes.IV. Public deposits are generally not available to new companies or companies with uncertain earnings.V. There are legal restrictions on the acceptance and renewal of public deposits. A company cannot raise unlimited amount from this source.VI. Receiving public deposits create unhealthy trends in capital market. There are numerous rates of interest offered by different companies.

This source of raising finance is valid only for short-term financial needs of the company. Recently this method has gained popularity to the extent that government companies start raising finance through this source.

1. Uncertainty:Public deposits are an uncertain and unreliable source of finance. The depositors may not respond when economic conditions are uncertain. Moreover, they may withdraw their deposits whenever they feel shaky about the financial health of the company.Depositors are entitled to withdraw their deposits at any time after giving prior notice to the company. During times of financial tightness or distress the depositors may get panicky and wish to withdraw their deposits.Moreover, if a large number of depositors simultaneously withdraw their deposits during slump, the company may find it difficult to repay a huge sum at once. Therefore, public deposits are described as ‘fair weather friends’.

2. Limited Funds:

A limited amount of funds can be raised through public deposits due to legal restrictions.

3. Temporary Finance:The maturity period of public deposits is short. The company cannot depend upon public deposits for meeting long-term financial needs.

4. Speculation:As public deposits can be raised easily and quickly, a company may be tempted to raise more funds than it can profitably use. It may keep idle money to meet future contingencies. The management of the company may indulge in over-trading and speculation which exercise harmful effects on the business.

5. Hindrance to Growth of Capital Market:Public deposits hamper the growth of a healthy capital market in the country. Widespread use of public deposits creates a shortage of industrial securities.

6. Limited Appeal:Public deposits do not appeal as a mode of investment to bold investors who want capital gains. Conservative investors may also not like these deposits in the absence of proper security.

7. Unsuitable for New Concerns:New companies lacking in sound credit standing cannot depend upon public deposits. Investors do not like to deposit money with such companies.

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.

The advantages of public deposits enjoyed by the investors are:

The interest rate is higher than the other financial investment instrumentsThe fund maturity period is short

The disadvantages of public deposits from the investors’ pint of view are: 

The interest that is charged on the public deposits does not enjoy tax exemptionThere is no pledging of security against public deposits

Regulating Public DepositsThe public deposits are regulated by the provisions of the Companies Act and the Companies (Acceptance of Deposit) Rules,1975. According to them, the following amounts are not included in the expression 'deposits':-

Any amount received from the Central Government or a State Government, local authority, foreign Government, any foreign citizen or authority or any other source whose repayment is guaranteed by the Central Government or a State Government

Any amount received as a loan from any banking company, State Bank of India or its subsidiaries, a nationalised bank or co-operative bank

Any amount received as a loan from any of the notified financial institutions Any amount received by a company from any other company Any amount received from an employee of the company by way of security deposit Any amount received by way of security or as an advance from any purchasing, selling or other

agents in the course of or for the purposes of the business of the company Any amount received by way of subscriptions to any shares, stock, bonds or debenture pending the

allotment of such shares, etc., and calls in advance on shares Any amount received in trust or any amount in transit

Any amount received from directors of the company or from its shareholders by a private company Any amount of unsecured loans brought in by the promoters in pursuance of stipulations of financial

institutions or loans provided by the promoters themselves and/or by their relatives but not by their friends and business associates.

Under the Companies Act and the rules framed thereunder, the invitation and acceptance of deposits by companies is subjected to the following conditions:-

Companies are not permitted to raise unlimited amounts of fund through public deposits. The aggregate of all outstanding deposits cannot exceed certain prescribed percentage of the paid up capital and free reserves of the company.

Invitations of deposits by a company can be made only by means of an advertisement specifying the financial position, management structure and other particulars relating to a company. A company which has defaulted in repayment of deposit or interest thereon is prohibited from inviting deposits.

The depositors shall fill the application form supplied by the company. The company in return issues a deposit receipt which is an acknowledgement of debt by the company. The terms and conditions of the deposit are printed on the back of the receipt. The company shall maintain a register of deposits containing the prescribed particulars and file returns of deposits duly certified by their auditor with a Registrar on or before 30th June of every year.

The interest to be allowed on such deposits by the company must be in accordance with the rate fixed by the Government. The rate of interest on deposits also varies depending upon the period of deposit and the reputation of the company.

The Companies (Amendment) Act,2000 has inserted certain new sections, in order to protect the interests of small depositors. The expression 'small depositor' means ''a depositor who has deposited (in a financial year) a sum not exceeding twenty thousand rupees in a company and includes his successors, nominees and legal representatives". In case of any default by the company in paying back to them, it shall inform the Company Law Boardwithin sixty days from the date of default. The Company Law Board will then direct the company to repay to small depositors within a period of thirty days from the date of receipt of intimation of default. On failure to comply with the orders of the Board, the company and its directors shall be punishable with imprisonment and payment of daily fine during the period in which such non-compliance continues. However, if such a defaulting company wants to invite deposits from small depositors, it shall state the complete nature of default in all its future advertisements and application form.

Besides, the Reserve Bank of India issues directives from time to time for regulating public deposits. These are aimed at safeguarding the interest of the public and to give them a feeling of security in investing in the public deposits. These regulations pertain to:-

The ratio of deposits to the paid-up capital and free reserves of the company The maximum duration of the deposits Obligation to invest a specified percentage of the deposit in a current or other account with a

scheduled bank free from any charge or lien, or in approved securities which shall be used only for the repayment of deposits

The filing of periodical returns with the RBI, giving the required information about public deposits/loans as well as furnishing of certain specified information on its financial position and working.