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Corporate deposits are an endless source of trouble

Unsecured corporate deposits by small savers have always been a troublesome product--it's time the government started a serious cleanup

Corporate deposits are an endless source of trouble

There have been a number of news articles recently about the harrowing time being faced by people who have invested in unsecured public deposits in companies. Off and on, we have gone through periods of such problems for decades now. Unfortunately, unless investors wisen up, and the government tightens the rules, there appears to be no end to companies simply refusing to refund such deposits.

The stories are all the same. Attracted by the high interest--generally about half to two per cent more than bank fixed deposits, investors put their money into such fixed deposits offered by companies. These deposits are unsecured and really have nothing backing them except the name of the company and its ability and willingness to return the money. There's always a steady stream of companies that stop paying interest and stop returning deposits that have matured. When the economy--or some sector--gets into trouble then this stream becomes a torrent, as it seems to have done so now.

I say 'seems to have' because there is no public source of aggregate data on this. Unlike data on shares issued by companies or investments in mutual funds, there is no ready way of knowing how much money is deployed in such deposits, how much of that is in companies that might be approaching financial trouble, how much of the money is with companies that have stopped paying interest and how much in those that have stopped redeeming deposits. So while news stories quote a variety of estimates to show how widespread the problem is, there is no way of actually knowing.

One of the things that investors and the mediapersons writing about such companies do not realise is that the very fact that a company is offering higher interest rates makes it suspect. Promoters do not offer higher interest deposits unless they have no other source of finance left. Only when banks, the equity market, the bond market, or other normal sources of raising money are inaccessible to a company does it turn to raising small deposits from individuals.

Even within the realm of such deposits, a company offers higher rates than others only when it's unable to compete on reputation alone with others. For example, there are a handful of trustworthy names raising such deposits, HDFC and Sundaram Finance being two prominent ones. However, they offer barely a quarter to half a percent above the bank rates. If a company is offering two or three per cent or even more above bank rates, then that itself makes it suspect. Of course, I have actually just described the principle of high returns coming with high risk. Unfortunately, too many investors who get attracted by such deposits do not seem to understand this.

While investors need to avoid these deposits, there is a fundamental problem of the product being quietly pushed to less knowledgeable savers by middlemen earning high commissions. There is a regulatory failure here that has continued for decades. The new Companies Act has tightened regulations on paper by requiring companies to get rated by a rating agency. Our official faith in these agencies is touching. However as every lender knows, the actual efficacy of these agencies leaves much to be desired, to say the least. One of the problems is that the nominal regulator of this activity, the Ministry of Corporate Affairs, is not oriented for proactive consumer protection activity.

This is a regulatory anomaly. Indian corporates raise money--both equity and debt--from the public in many ways. Every single one of them is regulated by SEBI--with sole and illogical exception of corporate deposits. When the country has a highly evolved financial regulatory system, leaving small depositor without any active regulator to protect them is sheer negligence. Corporate deposits should be shifted to SEBI's regulatory ambit without delay.

In theory, the new bankruptcy code will, at some point, offer a way out, but as unsecured creditors, deposit holders have to stand far back in the queue of those who will get anything out of a failed business. While the rating requirement may remove the worst potential deposit-takers, it's hard to see any real solution as long as these types of products continue. Limiting deposit-taking to a very small class of highly rated companies, plus increased transparency and a higher ticket size should be part of the cleanup of these deposits.

At the same time, for existing deposit holders of hard cases like Unitech, it's difficult to foresee any good news.