Loans against pledged shares can affect the health of the financial system and pose a risk to retail investors, RBI says in its financial reports of December 2013 and December 2014. (Aniruddha Chowdhury/Mint)
Loans against pledged shares can affect the health of the financial system and pose a risk to retail investors, RBI says in its financial reports of December 2013 and December 2014. (Aniruddha Chowdhury/Mint)

Banks, NBFCs ignored RBI caution on loans against pledged shares

  • Banks accounted for 3.11% of all pledged shares by value and NBFCs 12.79% at the end of December 2014
  • The percentages shot up to 14.47% for banks and 39.59% for NBFCs by the end of December 2018

Mumbai: Both banks and non-banking financial companies (NBFCs) ignored the Reserve Bank of India’s (RBI) words of caution on lending against pledged shares and continued the practice, shows data.

RBI had twice cautioned against the risk of lending against shares. In its financial stability reports of December 2013 and December 2014, RBI said such practices could affect the health of the financial system and pose a risk to retail investors.

While banks accounted for 3.11% of all pledged shares by value and NBFCs 12.79% at the end of December 2014, the percentages shot up to 14.47% and 39.59%, respectively, by the end of December 2018, shows data of NSE 500 companies sourced from Prime Database.

Experts said the regulator’s concern stems from the fact that the financial system is interconnected and any instability in one part rapidly spreads to other segments, as was witnessed in the recent liquidity crisis.

“In the normal course of action, promoters would have raised money from the market, reducing their stake in the process," said Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services, adding that in case of a default and an ensuing conversion of debt into equity, lenders might be left with a stake in a company that they do not want to be part of.

In 2013, RBI had cited a Securities and Exchange Board of India (Sebi) analysis of 4,274 listed companies to show that promoters had pledged some or all of their shares in those companies. Of these, promoters of 286 firms had pledged more than 50% of their shareholding.

In a December 2014 report, RBI had said that in some instances, the shares pledged by unscrupulous promoters could lose value and they might not mind losing control of the company as there was a possibility of diversion of funds before share prices collapsed.

The chief financial officer of a large state-run bank, however, defended the practice, saying problems arise only when shares are pledged to NBFCs and other corporations.

“There are covenants in loan agreements that any further pledges by a promoter shall have to be cleared by the consortium of existing lenders. It might not have been strictly enforced. But, owing to the recent events, we will be looking at ensuring no one bypasses them," he said on condition of anonymity.

While promoters have been pledging shares for several years, the information was not made public in the past. In 2009, Sebi mandated event-based disclosures, which must be made as and when shares were pledged, and periodic disclosures, along with quarterly filings with stock exchanges.

“Promoters pledging per se is not bad. It is one of the fastest and easiest ways of raising funds by a promoter. However, it can be harmful if promoters pledge a high percentage of their shares," said Pranav Haldea, managing director, Prime Database Group.

According to Haldea, Sebi should step in and put a cap on the percentage of promoter shares that can be pledged. There is also a strong need to plug various loopholes which exist in disclosures relating to promoter share pledging, he added.

In view of the recent revelations of large debts of majority shareholders/promoters of a few large listed Indian companies, analysts said there was a need for stronger corporate governance standards and additional disclosures on financials, debt positions and promoters’ pledge of shares.

“Current disclosures on pledged shares of promoters and related-party transactions of listed entities are helpful, but fall short of providing a complete picture to minority shareholders," Kotak Institutional Equities said in a 1 February note.

Kotak added that the current disclosures on promoter holdings are inadequate as most Indian promoters hold shares through holding companies and not in their own names. Besides, stock exchanges simply report the total number of shares held by promoters, without disclosing the primary entity that holds the shares.

Recently, Anil Ambani-led Reliance Group had reached a standstill agreement with more than 90% of its lenders to ensure that they do not sell any of the pledged shares till September. In another instance, Essel Group said it had sealed a formal agreement with its lenders, which gives it time till September-end to deleverage its balance sheet.

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