It was observed of late that there were episodes of rash sell-offs of shares of mid caps and small cap companies which compelled RBI to tighten the noose norms related to the loan against the shares and this will only redirect the promoters of these companies to find new sources of funding. Its a usual practice that if the investor wants to buy a stock than he has to put a part of money and the remaining balance will be borrowed by him from the lender .
Normally the investor or the promoter avail the loan against the shares by just pledging the shares funded, the power of attorney given to lender allowing him to sell the shares to recover the amount, as per the present rules the stock broker is allowed to fund only 50% of the transaction value and so also against the type of shares besides disclosing their position to the stock exchanges but there is no constraint on the margin funding by NBFCs, and naturally the lenders sell off the shares if the stock price falls at the undesired levels and so the client is not able to meet the margin call. So the new circular states that Non Banking Financial Sector (NBFC) cannot lend more than 50% of the value of the shares pledged as collateral while giving loan of Rs 5 lakhs and above.
NBFCs with an asset size of Rs 100 crore can accept only group 1 securities as collateral and will also have to disclose details of the shares pledged with them .And this move is very significant by the central bank which will be instrumental in checking risks of unwanted volatility in the equity markets as the market is too hyper bullish. The National stock exchange (NSE) has 694 stocks and the Bombay Stock Exchange has 817 scripts under the group 1. So many midcaps and small caps will be deprived of funding by NBFC , because for whatever reasons the manner or purpose the money is lent against the shares the default by the borrowers leads to the offloading of the shares in the market by the NBFC and thereby creating avoidable volatility in the market. Although it will be a bit difficult for the traders as their leverage positions get reduced significantly.