PTI
BEYOND A SAFETY NET: Though there have been far too many instances where
the public has been hoodwinked by the promise of above-normal returns,
these regulations could have a disadvantageous effect.
While the proposed rules under the new Companies Act 2013 are
laudable, the government must not end up closing an investment avenue
Learning its lessons from the collapse of several collective investment
schemes in recent times run by fly-by-night “companies,” the government
has proposed stringent rules under the new Companies Act 2013 to protect
depositors. Notified last week, these rules propose that companies
(other than non-banking finance companies) should henceforth insure the
deposits that they take from the public.
Rule 13 of the draft Companies (Acceptance of Deposit Rules) 2013
stipulates
that every company that invites public deposits should have
in place an insurance scheme at least a month before it advertises for
deposits. Every deposit and interest accrued thereon should be insured
against default in repayment. As per the proposed rules, where the
deposit value is below Rs.20,000, the insurance should cover the entire
deposit plus interest thereon. In case of deposits over this amount, the
insurance should cover repayment of at least Rs.20,000.
In other words, public company deposits will henceforth be insured for a
maximum of Rs.20,000. This is similar to the existing scheme for bank
deposits which are insured up to a maximum of Rs.1 lakh by the Deposit
Insurance and Credit Guarantee Corporation.
Not just this. Companies are also required to set aside a portion of the
public deposits they hold, whether secured or unsecured, in a Deposit
Repayment Reserve Account (DRRA) with a scheduled commercial bank.
Before April 30 each financial year, companies have to put away in the
DRRA 15 per cent of the deposits maturing during the financial year and
the one following that.
Adverse impact
Companies have also been barred from advertising abnormal returns and
from paying agent commissions that are not in line with Reserve Bank of
India regulations.
The objective of these rules — protecting depositors — is indeed
laudable. There have been far too many instances in recent times where
the public has been hoodwinked by the promise of above-normal returns.
Yet, the point is that the government should not end up closing an
investment avenue while trying to make it safer.
The regulations could have an adverse effect on the corporate deposits
market which is popular with senior citizens and other conservative
investors who shy away from riskier alternatives such as the stock
market.
The necessity to insure deposits and maintain a balance in a reserve
account will push up costs for companies. With the regulations clearly
specifying that the cost of insurance cannot be passed on to depositors,
companies may have to absorb the premium as a cost on their balance
sheets. The deposit repayment reserve account will also tie down funds
for the company. It is not clear if the company will earn interest on
this but even if it does, the rate may not be very high. Together, these
proposals will make public deposits an expensive source of funds for
companies.
Limited options
Given this, companies have just two options. Either they have to opt out
of the public deposits market or they have to build in the extra cost
of insurance into the interest rate they propose to pay. If they decide
to offer lower rates to compensate for the insurance cost, then it will
become difficult to attract fixed deposits as investors have a range of
options to choose from.
Company fixed deposits are not attractive even now given that the
interest received is subject to tax at the maximum marginal rate, which
is why they are limited to a select category of investors. Bank
deposits, which come with the same tax liability, are more popular for
the simple reason that they are insured. Given these, the proposed
regulations might end up making the corporate fixed deposits market
unviable.
Of course, it can be argued that the big, well-capitalised and safe
companies anyway do not accept deposits from the public. The main reason
for this is that the cost of compliance and servicing of deposits is
high. However, there are a lot of small and medium-sized companies from
well-established industrial groups that still use public fixed deposits
as a means of finance. It is this group that will now feel the heat
especially because they have a faithful investor base.
Striking a balance
So, how does one strike a balance between the important objective of
investor protection and preserving a popular investment option? One way
will be to do away with income tax on interest from fixed deposits, be
they with banks or companies.
Alternatively, the government can have a slab up to which fixed deposits
will be free of tax on interest. Companies can then have the
flexibility to offer reduced rates to adjust for compliance costs and
still keep their deposit schemes attractive. In the process, all the
three stakeholders will gain: investors will have safety; companies can
continue to access the fixed deposit market and the government will have
less to worry about safety of the financial system.
