Definition: Public Deposit can be described as a form of short-term financing, often unsecured in which the company invites deposits from the general public to fulfill its working capital requirements. In this, the general public, deposits money with non-banking companies. It is just like a loan raised by the company from the public. Here, the word public is an umbrella term for employees, customers, shareholders, and the general public.
Most importantly, a private company is not authorized to invite the general public to deposit money with the company.
Salient Features of Public Deposits
- Short-term source of finance: It is a short-term source of finance as the period ranges from 6 months to 3 years. But, the deposits are subject to renewal, i.e. it may be renewed at timely intervals.
- Form submission: The people who are interested in making public deposits can fill up the prescribed form and submit the same.
- Issue of Receipt: Once the form is submitted a receipt is issued by the company as an acknowledgment of debt at the time of accepting deposits that indicates the amount of loan received, interest rate, and date of payment.
- Mutual Benefit: In this arrangement both the depositors and the company are benefitted, as the depositors receive interest at a high rate, generally more than the rate offered by the banks on deposits. On the other side, the company may also find it cheaper to arrange money by way of public deposits than raising it from banks or other financial institutions. This is because the cost of deposits to the company is less in comparison to the cost of borrowings from banks. However, as the deposit is not secured by any collateral, it is highly risky.
- Interest Rate: The rate of interest offered by the companies varies from one company to another based on their reputation and the period for which the deposit is made.
Rules for Public Deposit
In order to prevent the malpractices of different companies like non-payment of interest and non-refunding money, several rules are made by the Government for its regulation. These rules are as under:
- The Reserve Bank of India decides the maximum rate of interest and brokerage payable.
- The maturity period allowed is a minimum of 6 months and a maximum of 3 years.
- The deposit amount should not be more than 35% of the total paid-up capital and general reserves or say free reserves.
- The use of such deposits is done to fulfill working capital needs and not to purchase fixed assets as they need to be repaid within 3 years.
- The company must maintain a register of depositors that comprises all the details relating to the public deposits.
- The company must keep aside deposit or investment by 30th April of value equal to 10% of the deposits maturing by the end of the next financial year, i.e. 31st March. Such an amount can be used to repay the public deposits only.
- Companies that invite public deposits need to state certain facts concerning the financial performance of the company.
Procedure of raising money through Public Deposits
The companies that look forward to inviting public deposits often place ads in the news dailies. The advertisement contains the major achievements as well as future prospects of the company and makes a formal request to the public to deposit their money with the company. The company also declares the interest rate, which varies according to the term for which money is deposited with the company. Additionally, the company also declares the time and payment mode and repayment of deposits.
In general, the company authorizes some firms that operate locally to perform the role of a broker, to render the services to the depositors.
Advantages of Public Deposit
- Economical: The company can get the public deposit at a very low cost, i.e. just by placing the ad in the newspaper they can get the necessary funds in a very short time. Also, it saves underwriting commission and brokerage. Most importantly, interest is a tax-deductible expense on the income. Besides, the overall administrative cost of deposits is comparatively less than the cost of issuing securities.
- Simple: The procedure of inviting public deposits is easy and uncomplicated, as it involves a few legal formalities only.
- Trading on equity: Due to the fixed interest rate, the company can get benefits from trading on equity because it can use the remaining profits to distribute to the shareholders in the form of dividends. So, it can pay a higher dividend to its equity holders, which will help in improving its reputation in the market.
- No charge on assets: As it is an unsecured deposit, no charge is required to be created on assets of the company.
- Eliminates Dependency: With public deposits, a large pool of investors can be approached, which eliminates the dependency upon the single financial institution or bank.
- No interference: As the funds are raised from depositors, who are not the shareholders so there is no interference from their side because they do not have voting rights.
Disadvantages of Public Deposits
- Uncertainty: Any person who has deposited their money can withdraw the same at any time. This makes public deposits an uncertain source of finance as premature withdrawals can affect the financial standing of the company badly.
- Fairweather friends: Despite many benefits, one cannot deny the fact that people usually go with the trend. And so, the company will get enormous deposits when its earnings disclose a rising trend. However, when there is a crisis-like situation, the depositors may view it as a ship that is sinking. So, they may withdraw their deposits, when the position is unsteady. That is why the public deposit is called fair-weather friends.
- Risk to investors: Due to lack of collateral, depositors’ investment is always at risk. The company’s management may use the deposits in the way they feel right.
- Restricts growth of the capital market: With the extensive use of public deposits, capital market growth is restricted. It disturbs the interest rate pattern which leads to the shortage of sound industrial securities.
- Speculation: With the help of surplus deposits, the company’s management may be enticed to involve in overtrading and speculation.
- Lack of Attraction for Professional Investors: Public Deposits do not attract professional investors, because of lack of security as mortgage or charge on company’s assets.
A word from Business Jargons
Before the emergence of the banking system in the country, people used to deposit their hard-earned money with renowned companies. However, nowadays, a number of firms be it large or small have solicited unsecured deposits as a major source of raising funds for working capital.