Say you have a
surplus & want to invest in a fixed deposit (FD). The choices are 9% from State Bank of India (SBI) for a year, 8%
from ICICI Bank, 11.25% from Hawkins Cookers, 10.25% from Prism Cement, etc.
The latter option looks most lucrative, by a good margin. But financial experts
wouldn't be too happy with this choice.
Reason: In the past, several companies have
defaulted in their commitments.
Recently, the
government stepped in to make these instruments safer. Its proposal of
mandatory insurance cover for deposits raised by companies from individual
investors, if implemented, could improve these instruments. The proposed
measures form a part of the draft rules in the new Companies Act (Rule 13).
"A company may
accept deposits from its members by passing a resolution at a general meeting
& subject to conditions as may be prescribed in the rules, including credit
rating, deposit insurance, depositing 15% of the amount of its deposits
maturing during the current and next financial years in a scheduled bank, and
so on," read the draft norms.
CORPORATE
AFFAIRS MINISTRY PROPOSES:
* * To insure deposits worth at least Rs 20,000
* * To rate company deposit issues for risk
assessment of the instrument
* * Companies deposit 15 % of deposits maturing
in current and next financial year in a bank
* * A penalty of up to 15 % against companies
not complying with the rules
* * Total deposit outstanding be equal to 25%
of companies' share capital and reserves
* * Companies should not promise huge returns,
hefty commissions to agents
* * Companies should not recover insurance cost
from depositors
* * A penalty of up to 18% annually on defaulting
companies
Mr. Sai
Venkateshwaran, Partner and Head (Accounting advisory services), KPMG India, if
this is effected, companies would have to redeem current deposits & raise
fresh money, in line with the new norms.
"In case of a
default, the company holding the deposit will have to refund the entire
principal & interest for those who invested less than Rs. 20,000. Deposits
of more than Rs. 20,000 may not be refunded completely, as the Act says only a
certain amount, as specified in the deposit contract, will be given back, or /
at least Rs. 20,000," he adds.
In other words,
public company deposits would henceforth be insured for up to Rs 20,000.
To safeguard
investors' interest & stop companies from being over-leveraged, the Act has
restricted companies to having outstanding deposits equal to 25% of their share
capital and reserves.
The Act also bars
companies from promising huge returns & hefty commissions to agents, in
excess of the prevailing rates prescribed by the Reserve Bank of India (RBI)
for such deposits. The premium paid can not be recovered from the depositor and
the money has to be paid by the company alone.
Also, the mandate
to maintain a balance in a reserve account would push up costs for companies.
It is not clear whether companies would earn any interest on the reserve
account, but it would not be much, even
if they do.
Simply put, these
proposals will make deposits an expensive source of raising funds. This means
companies might not offer the supernormal returns they mostly do to lure
customers.
On the flip side,
if companies don't offer rates higher than banks, they may find it difficult to
get depositors. As it is, company deposits are not tax-friendly and net returns
do not beat inflation. With lower returns, it would make even little sense to
invest in these.
However, do not get
carried away by the insurance component and mistake company deposits to be safe
instruments. Higher interest rates or insurance can't be the only criterion to
decide on investing in an instrument. Pay attention to the credit rating given
to each issue and the premium offered compared to bank deposits. If a company
is ready to pay you three per cent or more than market rates, it involves risk.
The trade-off between bank and company deposits might not be much in the long
term. Financial planners recommend 20% exposure in company deposits in the
overall debt portfolio, and that, too, only in those with high ratings - AAA or
AA+.
"Given the
insurance element may be introduced, there is no point in the government
stressing on credit rating of companies. As long as one is able to recover his
investments, why should he check the credit rating?" questions an
investment advisor.
Importantly, though
RBI has hinted at another round of rate increase, it is expected to cut rates
starting middle 2014. If it cuts rates, the rates of company deposits, too, would
fall. Conservative investors would be better off with bank deposits.
"The concept
of deposit insurance is a worldwide initiative being taken and gaining
popularity after the 2008-09 financial crisis. Any insurer, public or private,
can cover the deposits," says Mr. Ashvin Parekh, managing partner, APAS
LLP, and senior expert advisor (global financial services), EY.
According to
insurers & officials from the corporate affairs ministry, initially, the
Deposit Insurance and Credit Guarantee Corporation (DICGC) would insure company
deposits. Insurance companies would slowly be brought in, as changes need to be
made to the Insurance Act to incorporate cover for default risks. Currently,
the Insurance Regulatory and Development Authority does not allow covering of
default risks.
DICGC operates the
deposit insurance system. It insures all deposits such as savings, fixed,
current, recurring, etc, up to Rs. 1 lakh (for both the principal and interest
amount).
In comparison, the
Rs. 20,000 limit is small & the government could look at revising it
because investment experts say most company deposit holders invest at least Rs.
40,000.
"Such covers
need an insurance pool to be created, because these can not be specific to
companies' financials or / credit ratings. Insurance needs to be provided
across the board. There are many changes required before we can design such a
product" says Mr. Amarnath Ananthanarayanan, MD, Bharti AXA General
Insurance.
On defaulting, a
company would be levied a hefty penalty of up to 18% a year. Besides, any
violating company & each of its officers and other persons who could be in
default could be fined Rs. 10,000, with an additional fine of Rs. 1,000 for
every day of contravention for a continuing default.
Before April 30
each year, companies have to put away in a deposit repayment reserve account at
least 15% of the deposits maturing during the financial year and the one
following that. If implemented, the clause would lower the default risk in
company deposits that financial experts warn against.
Under the deposit
insurance scheme, companies would have to buy an insurance cover equivalent to
the total principal amount and the promised interest component to depositors.
The corporate affairs ministry would be initiating action against companies
failing to comply with the new rules - Regulations for Acceptance of Deposits
by Companies. Companies that do not provide insurance would be levied a penalty
of 15% a year.
Src: BS
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