Safety is the key: Why it's time for investors to shift from deposits to debentures

The recently notified Companies Deposits Rules 2014 together with the substantive legislation on the subject contained in sections 73 to 76 of the Companies Act, 2013 should make both the companies and investors wonder whether it is any longer prudent to set store by deposits when debentures would be win-win for both.

In the new regime, deposits from public, together with interest, up to Rs 20,000 per depositor must be insured. The deposit insurance premium dare not be recovered from the depositor is the admonition contained in the law for good measure. If a depositor has to be paid more than Rs 20,000, the excess over Rs 20,000 must be secured by way of charge on the assets of the company. This, together with the definition of eligible companies—-net worth of at least Rs 100 crore or turnover of at least Rs 500 crore—indeed are the measures in the interest of depositors, but should simultaneously exercise the minds of company managements on the wisdom of persisting with deposits.

Parenthetically, one wonders whether the mandatory insurance up to Rs 20,000 is to give business to insurers who are languishing in a country with very low insurance penetration because if a company has the resources to secure the entire deposits with its tangible assets (intangibles are a strict no-no for securing), why should the law carve out a portion of it for compulsory insurance.

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Debentures vs deposits

Debentures are transferable whereas deposits are by definition not. Thus money is locked up for the duration of deposit, and if premature withdrawal is sought, the company extracts its pound of flesh as allowed by the rules—1 percent reduction in interest rate by way of penalty vis–vis the interest payable for similar maturity.

To wit, if a depositor had placed some money on a three-year deposit carrying 12 percent interest, the entire calculation of interest would be done de novo at 10 percent if the interest for two years is 11 percent and the depositor had indeed approached the company for premature closure after two years.

A debenture on the other hand might change hands in the bourses painlessly. In fact, debentures could command a premium or suffer discount accordingly, as interest rates have come down or gone up vis–vis the coupon rate of the debenture given the fact that bond/debenture price are inversely related to interest changes. Debentures must be secured. And so must be deposits in the new milieu.

In the event, why should an investor invest in deposits and contrarily, why should a company not issue debentures discarding deposits? The new regime has obliterated the differences between deposits and debentures substantially by making both secured. What remains as a distinguishing feature is the transferability. Companies would do well to meet their working capital requirement for three years and beyond through issuance of debentures in their own interests as well as those of investors.

No difference in interest

Hitherto, depositors got a higher interest as recompense for their forbearance in accepting an unsecured status vis–vis the debenture holders. Now that both would be secured, the interest differential is likely to vaporize except for the fact that there would be more churning in debentures necessitating a full time registrar or department, whereas deposits can be counted upon to be more docile. But then for companies, the discomfiture caused to its registrar would be a small pinprick given the fact that its capital would not be disturbed.

In other words, while premature withdrawal of deposits on a large scale can upset the financials of a company, even a huge churn in debentures would not affect it given the fact that debentures change hands from one person to another in the bourses leaving the company and its capital and funds unaffected.

Lastly, a debenture can contain a convertibility clause but a deposit cannot. By issuing convertible debentures, a company can conserve its funds which is what late Dhirubhai Ambani did in Reliance more than three decades ago. That he did a bit of derring-do by converting non-convertible debentures into shares is another story. Debenture holders would not mind the metamorphosis in their status if it is agreeable to them i.e. the terms of conversion beget them discount in acquiring shares. No such tweaking is possible with deposits.