Introduction:

Inter-corporate deposits (ICDs) are loans or advances made by one company to another within the same group or conglomerate. These deposits are usually made for short periods and can be an attractive source of funds for the lending company. However, they also come with certain risks from the point of view of lenders.

Risks associated with inter-corporate deposits:

1. Credit risk:
ICDs expose lenders to credit risk, which refers to the potential for the borrowing company to default on its repayment obligations. This risk is particularly significant when lending to companies with weaker financial positions or uncertain business prospects. If the borrowing company fails to repay the deposit, the lender may suffer financial losses.

2. Concentration risk:
Lending a significant portion of funds as inter-corporate deposits can result in concentration risk. This risk arises from the fact that the lender's funds become highly dependent on the repayment ability of a single borrower or a few borrowers within the group. If any of these borrowers face financial difficulties or default, the lender's entire investment is at risk.

3. Lack of transparency:
ICDs may lack transparency, making it difficult for lenders to fully assess the financial health and risk profile of the borrowing company. In some cases, lending decisions may be influenced by personal relationships or informal arrangements within the group, rather than strict financial analysis. This lack of transparency increases the risk of lending to companies with poor financial management or governance practices.

4. Group-level contagion risk:
ICDs can also expose lenders to group-level contagion risk. If one company within the group faces financial distress or insolvency, it may have a ripple effect on other group entities. This interconnectedness can amplify the risk of default and negatively impact the repayment capacity of the borrowing company. Lenders may find themselves unable to recover their funds due to the financial troubles faced by other group companies.

Conclusion:
Inter-corporate deposits can be risky for lenders due to credit risk, concentration risk, lack of transparency, and group-level contagion risk. It is crucial for lenders to conduct thorough due diligence and assess the financial strength and repayment capacity of the borrowing company before extending such deposits. Proper risk management practices and diversification of lending portfolios can help mitigate these risks and protect lenders from potential financial losses.