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.


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