Adani Group fallout? NBFC loans against shares under RBI scanner

The Reserve Bank of India (RBI) has sought details of lending against shares and the largest credit exposures of non-banking financial companies (NBFCs).

The central bank’s Department of Supervision sought this information over the past week, and the deadline for submission of large exposure was on Monday, informed a source.
 

The RBI’s communiqué has been seen by Business Standard.
 

On lending against shares, the RBI said this would cover those accepted as collateral, or part of capital-market operations; transfer of shares by obtaining a power of attorney on dematerialised accounts of borrowers; or by any other means.
 

On credit exposures, the details sought are along the following lines: NBFCs’ 10 largest exposures — whether they be single or connected; exposures with a value equal to or above 10 per cent, or tier I capital; other exposures with a value at 10 per cent of tier I capital; and exempted exposures with a value equal or above 10 per cent of tier I capital.
 

“The information sought is aimed to get a sense of both sectoral (capital markets) and general leverage by big NBFC borrowers,” said another banker.
 

The Adani episode has also brought into sharp relief the concern flagged by the banking regulator in its Financial Stability Report of June 2019 (FSR:2019).

It had noted that the high level of pledging by promoters is seen as a warning signal, indicating the company’s poor health and probably a situation where the company is unable to access funding through other options.

Further, the increased pledging activity is risky for any company as debt repayment will leave no room for the company’s growth.

“As a general trend, promoters pledge shares when managing existing debt becomes tough for them, which eventually leads them to an increased debt trap that is detrimental to investor interest,” it said.

It was explained that in a falling market in particular, pledged shares are under pressure as diminished share prices bring down the collateral value, prompting lenders to either demand additional margins or sell shares to protect their interests. Either action can hurt stock prices, thereby eroding the wealth of investors.

"In effect, debt instruments backed by equity shares have a downside that is akin to that of a short put option on the underlying shares,” observed the FSR:2019.

Business Standard had on October 15, 2019, reported that the promoter pledge of shareholding is set to come under closer regulatory scrutiny, and a review of the guidelines is in the offing due to risks arising from both excessive leverage and the linkages between financial intermediaries. And the RBI, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority of India, and the Pension Fund Regulatory and Development Authority are expected to work closely to review the regulatory framework on the subject.

On the Radar

What’s been sought from NBFCs:

• Details of loans against shares (collateral or part of capital market operations); transfer of shares by obtaining power of attorney
• 10 largest exposures (single as well as connected)
• Exposures with value equal to or above 10%, or tier-1 capital
• Exempted exposures with value equal to or above 10% of tier-1 capital