Introduction: Reserve Bank of India (RBI) vide its notification dated August 21, 2014 has come up with amendment in norms for regulating lending against shares by (NBFC-SI), i.e. (NBFCs having a net worth of 100 crores or more) effective from Thursday, the 21st of August, 2014. Currently, loan against shares by NBFCs is not regulated by any specific guidelines apart from general prudential norms applicable to all NBFCs. The same is however, a part of lending and investment policies of NBFCs which ensures internal control for maintaining Loan to Value (LTV) ratio being risk assessment ratio that financial institutions and other lenders observe before approving a mortgage. Evaluation of high LTV is usually viewed as high risk involved and vice-versa.
Security cover for loan against shares
Currently, loan against shares is extended by NBFCs by way of:
(a) either on pledge of such securities
(b) transfer of securities or
(c) obtaining power of attorney of such shares and securities.
In the event of any default in repayment by the borrower, the lender NBFC exercises lien on the securities and offloads the same in the market. This results in volatility in the market. Moreover, non- reporting of shares pledged also exposes the securities to NBFCs.
Amendment vide the Notification:
Observance of LTV has always been an internal practice based on prudence; however, the notification puts a ceiling whereby NBFC-SIs shall be required to maintain a LTV ratio of 50 percent. This means that henceforth NBFC-Sis are prohibited from lending more than 50% of the value of shares pledged.
Besides this, NBFC-SIs are now permitted to only Group – 1 securities as collateral in the event the borrowed amount exceeds Rs. 5 lakh. The securities having mean impact cost of less than or equal to 1 and having traded on atleast 80% (+/-5%) of the days for the previous eighteen months, have been categorized as Group 1 by SEBI vide its circular dated March 11, 2013. This means such shares the price of which does not move more than 1 percent up or down when a block of those shares worth Rs. 5 lakh are bought or sold.
Reporting under the Notification:
Further, NBFC-SI, shall report on-line to stock exchanges, information on the shares pledged in their favour, by borrowers for availing loans. The format and mode of reporting has been put on the relevant stock exchanges and can be viewed at http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=9180&Mode=0#A1
Take on the Notification:
The amendment has been introduced in order to have control over the volatility in the market due to sudden sale of securities by NBFCs in event of default. Moreover, disclosure requirements have been introduced for transparency and information purpose. However, restriction on type of securities may result in the fall of eligible securities for availing loan. This may affect both borrowings and lending. Surely there is an additional compliance burden on NBFC-SIs.
(Author is associated with Vinod Kothari & Co. and can be reached at firstname.lastname@example.org)