Loans Direct Line

INTRODUCTION

Normally savings of surplus-spending units are transferred to deficit units either through direct or primary securities, such as shares and bonds, or through financial intermediaries. The market for loanable funds in India possess an additional channel for the transmission of funds, namely the acceptance of deposits directly from the public by manufacturing and other business concerns. There is no practice abroad of such loans direct line acceptance of deposits by companies from the savers. In India, the deposits can be regarded as a direct as well as indirect security or financial claim. The practice of acceptance of deposits by companies has become widespread and well established. The volume of such deposits has grown significantly.

WHO ACCEPTS SUCH DEPOSITS

Deposits in the present context of loans direct line are accepted from the public by

(a) Public and private limited non-banking and non-financial companies

(b) Public and private limited non-banking financial companies

(c) Government companies since 1980

(d) Branches of foreign companies

(e) Partnership firms

(f) Proprietary concerns

Among these different groups of companies, the non-financial ones account for the largest proportion of aggregate deposits. In this group of companies, the private limited companies and small companies depend more on deposits because of the difficulties they face in raising funds on the stock market and from the financial institutions.

TYPES OF DEPOSITS

Data on public deposits are available from the surveys conducted by the RBI. They are published periodically in the RBI bulletins. The aggregate deposits are divided into two categories, i.e. regulated deposits and exempted borrowings.

Regulated deposits are:

(a)Loans guaranteed by the former managing agents or secretaries and treasurers

(b)Unsecured debentures

(c)Deposits and unsecured loans guaranteed by directors in their personal capacity

(d)Deposits and unsecured loans from shareholders of the company

(e)Fixed deposits

(f)Deposits from associate members in the case of mutual benefit financial companies

(g)Other deposits

Exempted borrowings are:

a)Borrowings from former managing agents, secretaries, and treasurers

b)Money received from directors

c)Money from shareholders in the case of private limited companies

d)Security deposits from employees

e)Money received from purchasing, selling, and other agents

f)Money received from joint-stock companies of the same group or others

g)Other borrowings, i.e. loans from the government and security deposits from customers

h)Money received through debentures secured by immovable properties or convertible debentures

i)Inter-corporate deposits

j)Borrowings from banks and financial institutions

INTEREST RATES ON PUBLIC DEPOSITS

Interest rates on public deposits with companies are higher as compared to bank deposits and deposits with post offices, even after making an adjustment for tax concessions on the latter two types of deposits. Unlike bank deposit rates, earlier there used to be no ceiling on these rates. However, with effect from the beginning of the financial year 1981-82, a ceiling is imposed on interest rates paid by companies on public deposits. The level of rates charged by different companies is based on the financial position, reputation, management, size, overall profitability, and dividend history of the company concerned. This level is also related to the size of deposits, i.e. some companies loans direct line offer a higher rate if a single deposit is more than a specified amount. This amount varies from company to company. Large deposits should be encouraged to reduce the handling or administrative cost of deposits. Companies charge more from their shareholders, relatives, employees, charitable institutions, etc. Some companies offer reinvestment plans to depositors. Government companies also offer cumulative deposit schemes. There is a policy of relating the frequency of interest payment to the size of a given deposit, i.e. the higher the amount of deposit, the greater the frequency of interest payment. The maturity spread of interest rates varies from company to company. Interest rates on inter-corporate deposits are higher than those on other deposits accepted by companies. The rate of interest on six-month inter-corporate deposits is between 18-20 percent per annum.

Higher interest rates on public deposits are due to the nature of these deposits. The degree of risk borne by the saver is much greater if he holds deposit claims with non-banking companies. These deposits are unsecured, i.e. they are not backed by any of the assets of the company. Unlike bank deposits, they are not covered by any sort of insurance. Similarly, many companies are known to have refused to honor commitments when deposits were due or when depositors had wished to withdraw them. This created a psychology of fear in the minds of savers. These deposits are less liquid than bank deposits. Banks allow their fixed-deposit holders to withdraw the money without giving any notice in advance. On the other hand, some companies stipulate that deposits will not be repayable before the expiry of the period for which they are accepted.

Bank deposit rates are quite important to know because they give a price on the alternative sources for investment. They are also relevant because they represent a price on alternative sources of finance to the deposit-accepting companies. When bank deposit rates are reduced, it would not be possible to say immediately whether there would be a greater flow of deposits to the companies. This is because public deposit rates are likely to change when bank deposit rates are reduced. When bank deposit rates are reduced, there would always be a corresponding reduction in banks minimum advance rate. Public deposit rates will get reduced because of reduction in bank deposit rates and increment in the bank advance rate.

SOME ISSUES

The nature of public deposits is a debatable question in India. Some people think that these deposits are:

(a) Secondary securities and all organizations that accept them are financial intermediaries

(b) Short-term substitutes for money

It must be pointed out that while deposits with non-banking financial companies are secondary securities, those with non-financial companies loans direct line cannot be regarded as such because these organizations are the ultimate deficit-spending units. They use deposits, which are accepted for financing their own expenditures. Similarly, these deposits are unlikely to be substitutes for money balances, i.e. for cash or demand deposits with banks. When people invest in public deposits to earn a high return, public deposits cannot be regarded as the temporary abode of purchasing power.

An important issue is whether public deposits accompany savings or whether they represent a mere shift in the asset structure of savers. We can answer this question if we study the trends in the growth of substitutes for public deposits. There is a degree of competition between units and public deposits.

Does direct acceptance of deposit by companies pose a threat to the working of credit policy in the economy? It does, because expenditures financed with these deposits fall outside the mechanisms of the Central Banks control over the availability and cost of finance in the economy. When savings are channelized to ultimate spending units by a large number of dispersed suppliers of finance, the control mechanisms of the monetary authorities proves inadequate. For example, the RBI prescribes margin requirements under selective credit controls to check hoardings of commodities. When public deposits are used to finance those margins, the measure in question is directly weakened.

The increase in the volume of deposits with a company greatly affects its financial structure and the degree of financial risk borne by the companies. This will also affect the level of risk assumed by the depositors. The increase in these deposits raises the debt-equity ratio of companies, which in turn raises both the borrower and lenders risk. The situation would be the same if a company has to borrow funds from financial institutions directly.

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