Meaning of “public deposits”.
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.
Image Source: berarentals.files.wordpress.com/2013/05/security-deposit.jpg
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.
ADVERTISEMENTS:
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.
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.
ADVERTISEMENTS:
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.
ADVERTISEMENTS:
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.
The method of raising funds through public deposits suffers from the following limitations disadvantages:
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.