If Indian investors were asked to choose between fixed deposits and debentures, they would say that it is like choosing between the devil and the deep blue sea. On the face of it, fixed deposits (FDs) governed by Section 58 A of the Companies Act are extremely unsafe. They are unsecured and risky and even credit rating agencies that are expected to ring the warning bells by downgrading FD’s well ahead of a default have usually tended to react only after the event. Most often, the only details that an investor has about a company are those published in their statutory advertisements for raising deposits. Yet, so many individuals have sworn by company fixed deposits for several decades. After the Reserve Bank of India tightened the rules governing non-banking finance companies after the CRB collapse in 1997, there has been a clamour by investor groups to find ways of making fixed deposits raised by manufacturing companies safer too. In fact, RBI rules have made it impossible for all but the best companies to raise public deposits. Its stringent registration requirements have ensured that the number of ‘registered’ finance companies (that provide safer investment avenues) has dropped from a few tens of thousand around the country to just a few hundred. Some would argue that the RBI’s precipitous action in halting deposit taking without adequate notice had in fact led to the collapse of several companies and caused losses to investors. If the RBI found it tough to bring deposit-raising finance companies under control, then regulating manufacturing companies is far tougher, given the difficulty in keeping track of the deployment of funds.

The number of defaults and rollovers of fixed deposit repayments by Indian companies has risen steadily over the years. Large industry groups that were once considered perfectly safe have crumbled in the liberalised economy and defaulted on repayments, leading to growing disillusionment and panic among investors. When a company begins to defaults, it becomes painfully obvious that there is hardly any protection available for investors. They can go through the formality of filing complaints with the Company law board, a consumer court or the MRTP commission, but there is usually little chance of recovering their money.

Even those companies that rescheduled and staggered repayments following investor action have a pathetic record of sticking to their new schedules. This has led to a clamour from investor associations to insure fixed deposits on the lines of the Deposit Credit Guarantee Corporation. Alternatively, it is suggested that the government should consider barring manufacturing companies from raising unsecured funds from the public. Some argue that this would amount to throwing out the baby with the bathwater, since many blue chip companies, especially closely held (and deemed public limited companies) ones have remained safe investments for decades.

However, there are those among us who believe that blue chip companies, which are safe investment bets, could just as well raise funds through bonds and secured debentures. In other words, manufacturing companies should indeed be barred from raising money through fixed deposits and be compelled to mobilise funds through the issue of equity or secured debentures. After all, debentures have several positive features. First, they are secured against a charge on specific assets, and investors (through the debenture trustee) can demand that the asset be liquidated in order to repay their money.

Moreover, debentures can be listed on stock exchanges making them far more liquid and much easier to pledge to raise funds.

But that is the rosiest scenario. In fact, companies issuing debentures have defaulted with as much regularity as those that raised fixed deposits. A survey of “Indian household investment preferences”shows that corporate bonds are at the bottom of the heap of investment options among all income classes. What is worse, the horrors of investing in secured debentures become apparent only when the interest cheques stop coming in.

Investors then discover that banks and institutions that collected fees act as ‘debenture trustees’ invariably fail to fulfil their fiduciary duties. Often, they would not even have created a legally enforceable charge on the asset and are unwilling to liquidate it because it is usually bundled with other assets secured against term loans provided by the same institution. Can investors look forward to being extricated from their trap between a rock and a hard place? The Department of Company Affairs, through the Investor Education and Protection Fund (IEPF) has tried to look at some options; but they have in fact thrown up more questions than answers. For instance, the IEPF group discovered that insuring deposits was easier said than done. All insurance companies believe that fixed deposits are not an insurable risk, since it varies based on the management capabilities and ethics of each company. The insurance industry has made it clear that it has no interest in insuring fixed deposits at all. Ajay Shah, consultant to the Finance Ministry however suggests that it is possible to insure fixed deposits, but it could only be done by developing a credit derivatives market rather than through insurance route.

But before any government agency debates the issue of deposit insurance, it is painfully obvious that both fixed deposits as well as corporate bonds/debentures need a drastic rehaul of their regulatory and supervisory cover. Yet, it is also clear that opaque and unsecured fixed deposits will remain much riskier than bonds and debentures. The question is should fixed deposits by manufacturing companies be phased out? Clearly, the corporate sector will oppose such a move with great vehemence. If FDs are unsafe, risky and non-transparent, it suits them fine. The question is, will investors at least support a move to phase out fixed deposits by manufacturing companies? If investors have a strong opinion on the issue, then this is the time to write to the Secretary, Department of Company Affairs and make their voice heard. On the other hand, would retail investors be willing to look at corporate debentures afresh, albeit with tightened rules, better regulation and stringent action against wilful defaults? Individual investors and investor associations who support the latter effort should also survey their members and send their views to the DCA and Sebi. Either way, it is imperative that investors in fixed income securities are better protected by the regulators in order to reopen a nearly defunct investment avenue. This is in the interest of companies as well as investors.