Banks now to play slow numbers on Dalal St

RBI ups risk weight on capital market exposure by a quarter percentage point

Days after finance minister P Chidambaram cautioned against the irrational exuberance in the stock market, the Reserve Bank of India (RBI) today sought to shield banks by increasing risk weight on exposure to capital market by a quarter percentage point to 125 per cent.

The market was unfazed by the move as the Bombay Stock Exchange sensitive index touched a new high today at 7552.77, gaining 47 points. The RBI measure will effectively increase capital requirements of the banking system for capital market exposure to about Rs 350 crore from about Rs 250 crore based on the aggregate exposure as on March 31, 2005.

Dena Bank chairman M V Nair said the increased risk weight will also lead to banks charging higher interest rate on loans to capital markets to factor in the higher capital requirement.

The RBI move follows Chidambaram's warning to investors last week against getting over-excited about spiralling stock market and his advice to them to respond in a measured way.

The Securities and Exchange Board of India (Sebi) chairman M Damodaran too sounded a word of caution to investors saying they need to take informed decisions for a reasonable return.

Banks' advances to the upbeat capital market were up nearly 40 per cent to Rs 2,869 crore in 2004-05. Banks are already constrained by the ceiling on exposure to capital market. Banks' exposure to capital market can be a maximum of 5 per cent of their respective outstanding advances at the end of the previous year.

Jitendra Panda, vice-president, retail broking, Motilal Oswal Securities, said there would not be a major impact on markets but the extremely leveraged brokers might face a liquidity crunch.

The RBI's intention was to control extra volatility and indicate banks to have a cautious approach towards funding at current levels, he added. There are a very few brokers who are largely leveraged with bank financing, said a stock market intermediary.

Bankers said the increase in risk weights is another means through which RBI wants to ensure credit flow to the upbeat capital market is not at the cost of industrial sectors. It also ensures that banks will back their high-risk lending by higher capital.

The capital market exposure of banks includes investments in equity shares, convertible bonds and debentures and units of equity oriented mutual funds, advances against shares to individuals for investment in these instruments and secured and unsecured advances to stock brokers and guarantees on their behalf.

Banks' capital market exposures cover direct investment by a bank in equity shares, convertible bonds and debentures and units of equity-oriented mutual funds.

Besides advances against shares to individuals for investment in equity shares (IPOs and ESOPs), bonds and debentures as well as secured and unsecured advances to stock brokers and guarantees issued on behalf of stock brokers, are also covered by it.