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Revised Norms For NBFC Lending Against Shares

Published on Sat, Aug 30,2014 | 14:26, Updated at Sat, Aug 30 at 14:26Source : 

Revised Norms For NBFC Lending Against Shares

By: Aashit Shah, Partner, JSA

On August 21, 2014, the Reserve Bank of India (“RBI”) issued a circular (“Circular”) regulating lending by non-banking financial companies (“NBFCs”) against shares of companies. Until then, NBFCs were not subjected to conditions on loan to value (“LTV”) ratios when lending against shares as collateral, although they were understood to have sufficient internal controls when granting such loans. The intention of the Circular is to curb (a) volatility in the capital markets as a result of pledge enforcement by NBFCs, (b) overleveraging of borrowers and (c) overexposure of NBFCs to certain stocks.

The Circular requires that effective from August 21, 2014, NBFCs that have an asset size of Rs. 100 crores or more must ensure the following when granting loans against collateral of shares:
(a) They must maintain an LTV ratio of 50%; and
(b) They should accept only certain types of securities (i.e. Group I securities as classified by SEBI in its circular of March 11, 2003) as collateral for loans of a value of more than Rs. 500,000. This would be subject to further review by RBI.
Further, such NBFCs have to report on-line (in a prescribed form) to stock exchanges where the shares are listed, information on the shares pledged in their favour by borrowers for availing loans.

The Circular, read together with the prudential norms for non-deposit a ccepting or holding NBFCs, suggests that these norms will not be applicable to:
(a) non-depositing accepting or holding NBFCs which are investment companies (that invest in securities of group/holding/subsidiary companies where the book value of such securities is atleast 90% of the total assets of the NBFC and the NBFC does not trade in such securities); and
(b) core investment companies.

However, the Circular will certainly increase compliance and reporting requirements of other NBFCs with an asset size of Rs. 100 crores or more. While the rationale of the RBI is laudable, there are certain issues in the Circular which, in our view, need to be revisited or clarified.

Firstly, while the Circular requires an NBFC to maintain an LTV of 50%, it does not clarify how the value of the securities is to be computed i.e. whether it is based on daily opening or closing prices, or a periodic average of prices or some other methodology? Since there is an obligation to “maintain” an LTV of 50%, it is critical to understand how this LTV should be calculated and monitored periodically. There should also be a provision where the NBFC has the ability to ask for a top-up within a certain period if the LTV falls below 50%. The Circular also restricts the type of securities for loans exceeding Rs. 500,000 to only Group I Securities (as per the aforementioned SEBI circular). Does this mean that if Group I Securities become Group II Securities during the loan tenure, the shares must be substituted with Group I Securities, or is this a requirement to be followed only when granting the loan?

It is also unclear whether the requirements need to be complied when shares are not the primary security for a loan, and there is alternative primary security, in the form of immoveable or movable assets, which has been offered. Ideally, these requirements should only apply where shares are the primary or only security for a loan, but the Circular is silent, leaving room for debate.

In our view, the Circular should have prescribed a minimum loan amount or minimum percentage of shares pledged, for which the disclosures are mandatory to stock exchanges. Sale of a miniscule percentage of shares may not result in market volatility as these could also be for defaults on loans by individual / retail shareholders, which does not accurately reflect on the credibility of the promoters or company.

Further, the Circular is silent on the time-frame within which a disclosure has to be made by the NBFCs. RBI also needs to keep in mind that some individual / retail shareholders may avail loans for a very short duration (sometimes a few days), and disclosures for pledges created for such short term loans may lead to an information overload as the loans may have been repaid before the disclosure is made or soon thereafter. Also, presumably the disclosure is not required for existing loans granted with shares against collateral or restructuring or extension of such loans, but the same should be explicitly clarified by RBI.

Another crucial point which is not addressed is the requirement for a disclosure when the pledge is released or invoked. This ought to be there so that there is accurate dissemination of information to public shareholders.  

It is imperative that the RBI revisits the Circular and provides additional clarity on the above issues at the earliest to ensure effective implementation.

(Ronak Thakkar, Associate, JSA also contributed to this article. Their views expressed herein are personal)



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