The advantages are obvious. Investors can bring in a smaller quantum of their own funds to invest in IPOs, and if they get allotments, they can also sell the shares in the market and pay off the banker. If the listing is at a premium, they can make a neat profit. All with very little of their own funds.
How does this work? According to RBI norms, those wishing to invest in IPOs must bring in 40 per cent of the total investment amount as margin money. The maximum amount that a bank can finance is Rs 10 lakh. A 40 per cent margin means that if an investor wishes to invest Rs 10,000, he has to fork out Rs 4,000.
However, banks finance only those IPOs that are likely to be oversubscribed by three-four times. They take the help of brokers and merchant bankers to determine the pulse of the markets and whether the issue will be a success with the public. This minimises the probability of getting money stuck in dud issues.
An oversubscription also means that companies will return the excess money. Take the case of the Uco Bank issue, which was oversubscribed many times over.
When oversubscription money is returned, banks usually charge interest for the period the money was lent; but some banks forgo this for small investors by loading the cost of money on to the documentation fee charged.
But what if an issue is not oversubscribed and the allotment of shares takes place in the manner specified in the offer document? In this event, the bank would have to put in its own balance money in addition to the margin money that the investor brings in. The interest meter starts ticking. The rates charged are in the range of nine to 12 per cent.
Since the investor has already put in 40 per cent of the money, banks may not ask the borrowers to liquidate the shares to recover the money.
The shares are pledged in the bank's name and sold only if the value of the shares looks like falling below the margin money level. Investors, however, have the option to pay off the bank and keep the shares.
