Over the past couple of weeks, several mid caps have tumbled. State-owned power producer NHPC, crashed eroding several thousand crores of investor wealth in a couple of trading sessions. Top management of the firm took pains to explain that there was nothing untoward in the fundamentals of the company and that even the Union Budget was not “negative” to the hydro sector. NHPC was not alone, several midcap names crashed between 10 to 50%.
What then is causing these sudden crashes? While market participants have simply described them as margin calls, these are not the usual margin calls which are triggered by falling shares in a bear market. Neither has there been any great fundamentals surprise like the NHPC chairman said nor was there an international trigger that has hit the Dalal Street. The trigger, astute market players and banking law experts said, could be lying a few hundred metres North-east in the Mint Road.
Some non-banking finance companies (NBFCs), which dominated the margin funding business, are pruning their capital market exposure as some of these are aspiring to apply for bank licences under the norms released by the Reserve Bank of India (RBI) last month. According to the new framework, the promoter / promoter group will be permitted to set up a bank only through a wholly-owned Non-Operative Financial Holding Company (NOFHC). Further the consolidated NOFHC “shall adhere to all the exposure norms on the consolidated basis such as single and group borrower exposure limits, capital market exposure limit etc, as applicable to bank groups.” The norms added that, “the consolidated NOFHC’s investments in the capital instruments issued by banking, financial and insurance entities outside its Group together with the unconsolidated financial and insurance entities within the Group should not exceed 10% of its consolidated capital funds.”
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“These margin calls are not triggered at the client level, these were triggered at the lender level,” said a senior official with a foreign brokerage. According to him, a couple of Delhi-based institutions, which is are angling for banking licences, are leading the list of sellers.
“Lenders are calling back the margin loans. It is not easy for investors to get alternative funding at a short notice. This is leading to a sell-off,” added the official.
Shinjini Kumar, director at PwC said although it may not be necessary for bank license aspirants to prune their capital market exposure immediately but they can't continue with high capital market exposure. “Calling back margin loans could be done with the intention to alignment of that strategy. RBI has said that the capital market exposure will be considered at a consolidated level. Therefore, it will be necessary to for NBFCs to re-work their capital market exposure on a consolidated basis.”
Several Non-banking finance companies are in the race to acquire the new licences. Some of these which have operated in the capital markets have significant exposure to stocks both at the proprietary level and also in capacity as margin funders. Margin funding books were not looking good for many capital market entities in the first half of the fiscal with borrowing costs remaining high and stock prices beaten down. However, the the run-up in the stocks in the past few months had led to an increasing demand for margin funding.
A recent report by rating agency Icra said, “Increasing retail participation in the equity capital markets have also led to a return of the demand for margin funding. Consequently, brokers have been turning their attention to ramping up their margin funding book. As per anecdotal evidence in the last 2-3 months, margin funding / LAS book sizes for brokers have increased by 20-30%.”
Some analysts feel though several NBFCs may be exceeding the limits of capital market exposure it may be too early for NBFCs to begin bringing down exposures. “The RBI might allow enough time for the applicants to comply with these norms,” said an analyst with Espirito Santo Securities.
What constitutes capital market exposure
Banks' capital market exposures would include both their direct exposures and indirect exposures. The aggregate exposure (both fund and non-fund based) of banks to capital markets in all forms would include the following:
1 Direct investment in equity shares, convertibles and equity mutual funds
2 Advances against shares/bonds/debentures or other securities or on clean basis to individuals for investment in shares (including IPOs/ESOPs), convertible bonds, convertible debentures, and units of equity-oriented mutual funds;
3 Advances where shares are taken as primary security;
4 Advances to the extent secured by the collateral security of shares
5 Advances to stockbrokers and guarantees issued on behalf of stockbrokers and market makers;
6 Loans to corporates against the security of shares / bonds/ debentures or other securities
7 Bridge loans to companies against expected equity flows/issues;
8 Financing to stockbrokers for margin trading;
9 All exposures to Venture Capital Funds (both registered and unregistered).
Source: RBI Master circular
