Banks need to monitor double leveraging, share pledging by India Inc

Promoters in India often pledge shares not for funding outside business ventures but for the company itself

Banks need to be cautious of practices such as double leveraging and share pledging to stem asset quality risks, the Reserve Bank of India (RBI) said on Monday.

Excessive leverage by corporate groups is a major source of concern for banks across the world. A report by the International Monetary Fund (IMF) has flagged that trends in corporate leverage ratios in emerging Asian economies, including India, represented a “fault line” with the potential to amplify shocks, as global liquidity tightens, interest rates rise and growth slows.

In India, a practice popularly known as double leveraging is prevalent, particularly in the infrastructure space. In a typical double leveraging case, a holding company raises debt on its balance sheet and infuses it as equity in special purpose vehicles (SPVs).

“From lenders’ perspective, a debt-to-equity ratio of 2:1 at the holding company level could transform into a leverage of 8:1 at the SPV level. While there could be some merit in such practices, risk assessments by banks need to capture this effectively,” the banking regulator said in its Financial Stability Report.

Pledging of shares by Indian promoters was another area of concern. While such a practice exists in some of the advanced economies, it has taken a different form in India. Here, promoters often pledge shares not for funding outside business ventures but for the company itself. The promoters have no personal liability other than to the extent of their pledged shares. In certain cases, the shares pledged by promoters fall in value, but the promoters do not mind losing control of the company, as they might have diverted funds before the share price collapse.

“While a lender has the option of selling the shares when prices fall and hit a point that can be called a default event, this can still have an impact on minority shareholders... In view of the prevalence of promoters pledging a substantial portion of their shares, the resultant leverage could be a concern not only for shareholders but also for the health of the financial system. This issue calls for a closer examination,” RBI said.

The central bank also urged lenders to review and strengthen the accountability mechanism in reference, approval, and implementation of loan restructuring cases to the corporate debt restructuring (CDR) cell. “With increased regulatory focus on segregating cases of wilful defaults and ensuring adequate equity participation of promoters in the losses leading to defaults, there is a need for greater transparency in carrying out a net economic value impact assessment and audit of big-ticket CDR cases,” said RBI.

While the number of cases referred to the CDR cell has declined in the recent past, according to RBI, it might be because banks are now allowed to restructure their large credits with aggregate exposure of Rs 100 crore and above outside CDR under the joint lenders’ forum.

Industry-wise position on proportion of promoters' pledged shares (as of March, 2014)

Sector	Indian Promoters	Foreign Promoters	Total Promoters' Holding	Promoters' Ownership Pledged
	(in per cent)
Services	46.3	9.7	56.1	25.5
Media & Entertainment	44.3	5.2	49.4	24.9
Manufacturing	50.5	7	57.5	18.1
Infrastructure	69.8	1.1	70.9	14.7
Telecommunication	51.4	5.8	57.3	12.8
Total	51.6	4.6	56.3	14.2

Source: National Stock Exchange