Banks and NBFC companies give loan against Share in the form of overdraft against the shares held by the customer of the said company.
It is the best way to get instant liquidity without selling their shares or securities, and once the loan is repaid.
The customer gets back the shares which were pledged, and there is no need of liquidation of stocks.
The problem arises when the customer is unable to repay the debt, and the NBFC is forced to keep the stocks with themselves, and when share prices fall a certain level, in that case, NBFCs sells the shares against which they had provided the customer loan.
Usually, with this, it results in a severe fall in the company’s stock.
Therefore, this amendment has been made to protect the market from volatility due to immediate sale of securities by NBFC companies in case of default in the payment of the loans given against them.
The NBFC companies which come under the ambit of the circular published by RBI are companies which have an asset size of Rs.100 crores
Following aspects of the company are assured before granting a loan against the collateral of shares:
(a) The NBFC must maintain an LTV ratio of 50%.
(b) They should only accept Group securities as classified by SEBI in its circular of March 11
Prior to circular mentioned above, NBFC was not regulated by any specific guidelines regarding loan against shares provided by them to their customers, the only regulation which was followed were prudential norms which were to be followed by all type of NBFC’s.
These Prudential norms were lending, and investment policies of NBFCs which ensured internal control for maintaining the Loan to Value ratio being risked assessment ratio that financial institutions and other lenders observe before approving a mortgage. Evaluation of high LTV is usually viewed as the high risk involved and vice-versa.
Read also: Ombudsman Scheme for NBFC
The directions prescribe NBFC guidelines on asset classification, income classification and provisioning requirements applicable and requirement of capital adequacy. Deposit accepting NBFCs have also to conform to the statutory liquidity requirements.
These disclosure requirements have been introduced for transparency and information purpose. However, restriction on these types of securities may result in the downfall of eligible securities for availing the loan. This may affect both borrowings and lending. This may be an additional compliance burden on NBFC-SIS, but an important one as these norms protect the market from the volatility of providing loans against shares.