Banks offer loans against securities for customers’ short-term funding needs. Loans against shares, government bonds, insurance policies, NSCs, and other investments come under this category.
For loans against shares, debenture banks are required to strictly observe regulatory restrictions on ‘Exposure Norms’ as explained below.
Restrictions on Holding Shares in Companies
In terms of Section 19(2) of the Banking Regulation Act, 1949, banks should not hold shares in any company except as provided in sub-section (1) whether as pledgee, mortgagee, or absolute owner, of an amount exceeding 30 percent of the paid-up share capital of that company or 30 percent of its own paid-up share capital and reserves, whichever is less.
Further, in terms of Section 19(3) of the Banking Regulation Act, 1949, the banks should not hold shares whether as pledgee, mortgagee, or absolute owner, in any company in the management of which any managing director or manager of the bank is in any manner concerned or interested.
Therefore, when a bank is granting loans and advances against shares, statutory provisions contained in Sections 19(2) and 19(3) should be strictly observed.
Advances to individuals:
Banks may grant advances against the security of shares, debentures, or bonds to individuals subject to the following conditions:
- No advance against partly paid shares shall be granted.
- No loans are to be granted to partnership/proprietorship concerns against the primary security of shares and debentures.
- Banks operating in India should not be a party to transactions such as making advances or issuing backup guarantees favouring other banks for extending credit to clients of Indian nationality/origin by some of their overseas branches, to enable the borrowers to make investments in shares and debentures/bonds of Indian companies.
- Banks should ensure that the scrips lodged with them as security are not stolen / duplicate/fake / Benami. Any irregularities coming to their notice should be immediately reported to RBI.
- The Boards of Directors may decide the appropriate level of authority for sanction of advances against shares/debentures. They may also frame internal guidelines and safeguards for the grant of such advances.
Purpose of the Loan:
Loan against shares, debentures, and bonds may be granted to individuals to meet contingencies and personal needs or for subscribing to new or rights issues of shares/debentures/bonds or for purchase in the secondary market, against the security of shares/debentures/bonds held by the individual.
Limit of loan or advance:
An individual may be granted a loan against the security of shares, debentures or bonds should not exceed the limit of Rupees ten lakhs per individual if the securities are held in physical form and Rupees twenty lakhs per individual if the securities are held in dematerialised form. The limit/limits of advances granted to a borrower exceeds Rupees ten lakhs, it should be ensured that the said shares/debentures / bonds are transferred in the bank’s name and that the bank has exclusive and unconditional voting rights in respect of such shares. For this purpose, the aggregate of limits against shares/debentures / bonds granted by a bank at all its offices to a single borrower should be taken into account. Where securities are held in dematerialised form, the requirement relating to the transfer of shares in the bank’s name will not apply and banks may take their own decision in this regard. Banks should, however, avail of the facility provided in the depository system for pledging securities held in dematerialised form under which the securities pledged by the borrower get blocked in favour of the lending bank. In case of default by the borrower and on the bank exercising the option of invocation of pledge, the shares and debentures get transferred in the bank’s name immediately. (Banks may take their own decision regarding the exercise of voting rights and may prescribe procedures for this purpose).
Margin:
The loan or advance against equity shares / convertible debentures held in physical form maintains a minimum margin of 50 percent of the market value. In the case of shares / convertible debentures held in dematerialised form, a minimum margin of 25 percent should be maintained. These are minimum margin stipulations and banks may stipulate higher margins for shares whether held in physical form or dematerialised form. The margin requirements for advances against preference shares / non-convertible debentures and bonds may be determined by the banks themselves as per the Loan Policy of the Bank approved by the Board of Directors.
Banks should obtain a declaration from the borrower indicating the extent of loans availed of by him from other banks as input for credit evaluation. It would also be necessary to ensure that such accommodation from different banks is not obtained against shares of a single company or a group of companies. As a prudential measure, each bank may also consider laying down appropriate aggregate sub-limits of such advances.
Advances to Share and Stock Brokers/ Commodity Brokers:
Banks shall grant advances only to share and stock brokers registered with SEBI and who comply with capital adequacy norms prescribed by SEBI / Stock Exchanges. Share and stock brokers/commodity brokers may be provided need-based overdraft facilities/line of credit against shares and debentures held by them as stock-in-trade. However, Banks and their subsidiaries should not undertake financing of ‘Badla’ transactions. The ceiling of Rupees ten lakhs / Rupees twenty lakhs for advances against shares/debentures to individuals will not apply to them. Limits should be sanctioned on a need basis, taking into account the financial position of the borrower, operations on his own account and on behalf of clients, income earned, the average turnover period of stocks and shares, and the extent to which the broker’s funds are required to be involved in his business operations. However, Large scale investment in shares and debentures on own account by stock and share brokers with bank finance, should not be encouraged. The securities lodged as collateral should be easily marketable.
A uniform margin of 50 per cent shall be applied on all advances/financing of IPOs / issue of guarantees on behalf of share and stockbrokers. A minimum cash margin of 25 per cent (within the margin of 50%) shall be maintained in respect of guarantees issued by banks for capital market operations. The above minimum margin will also apply to guarantees issued by banks on behalf of commodity brokers in favour of commodity exchanges viz. National Commodity & Derivatives Exchange (NCDEX), Multi Commodity Exchange of India Ltd. (MCX), and National Multi Commodity Exchange of India Ltd. (NMCEIL), instead of margin requirements as per the commodity exchange regulations. These margin requirements will also apply to bank finance to stock brokers by way of temporary overdrafts for Delivery-versus-Payment (DvP) transactions.
Banks may grant working capital facilities to stock brokers registered with SEBI and who have complied with capital adequacy norms prescribed by SEBI / Stock exchanges to meet the cash flow gap between delivery and payment for DvP transactions undertaken on behalf of institutional clients viz. FIs, Flls, mutual funds, and banks, the duration of such a facility will be short and would be based on an assessment of the financing requirements keeping in view the cash flow gaps, the broker’s funds required to be deployed for the transaction, and the overall financial position of the broker. The utilisation will be monitored based on individual transactions. Banks may institute adequate safeguards and monitoring mechanisms.
Banks may issue guarantees on behalf of share and stock brokers/commodity brokers in favour of stock exchanges instead of security deposit to the extent it is acceptable in the form of bank guarantee as laid down by stock exchanges. Banks may also issue guarantees instead of margin requirements as per stock exchange regulations. The bank should assess the requirement of each applicant borrower; and observe usual and necessary safeguards including the exposure ceilings.
The requirement relating to the transfer of shares in the bank’s name in respect of shares held in physical form shall not apply in respect of advances granted to share and stock brokers provided such shares are held as security for a period not exceeding nine months. In the case of dematerialised shares, the depository system provides a facility for pledging and banks may avail themselves of this facility, and in such cases there will not be a need to transfer the shares in the name of the bank irrespective of the period of holding. The share and stock brokers are free to substitute the shares pledged by them as and when necessary. In case of a default in the account, the bank should exercise the option to get the shares transferred in its name.
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