Question

A company has to meet its short-term financial needs. It is considering whether it should raise loans from commercial banks or invite public deposits. Discuss the merits and demerits of each form.

Answer 1

Raising funds from commercial banks offer the following advantages:

1. Banks provide funds to business firms as and when needed. Timely financial assistance is available.
2. Banks keep the information given by the borrowers confidential. Secrecy of business is maintained.
3. Banks are an easier source of funds because issue of prospectus, and underwriting formalities are not involved.
4. Bank loan is a flexible source of finance as the loan amount can be increased or repaid as per the needs of business.

Bank finance suffers from following disadvantages:

1. Finance is available for short periods. Extension or renewal of loan is difficult and uncertain.
2. Procedure for raising finance is cumbersome as banks make detailed investigation of the borrower's business.
3. Banks insist on personal guarantees and security of assets.
4. Banks many put restrictions on the sale of mortgaged goods causing difficulty in the working of business.

The merits of public deposits are:

1. Obtaining deposits is simple and free of restrictive requirements typically found in lending agreements.
2. Public deposits typically cost less than borrowings from banks and financial entities.
3. Public deposits normally do not generate a levy on the company's assets. Assets can be used as collateral for borrowing from other sources.
4. As the depositors do not have voting rights, the control of the company is not diluted.

The major limitations of public deposits are as follows:

1. New enterprises find it difficult to raise cash through public deposits.
2. The public may not respond to a company's financial requirements, making it an unreliable source of funding.
3. Collecting public deposits can be problematic, especially for big amounts.