Sebi joins hands with RBI to check shady stock deals of NBFCs

As markets watchdog Sebi joins hands with banking regulator RBI to check 'pumping and dumping' of stocks by NBFCs, these lenders would have to soon mandatorily disclose details of shares pledged with them.
The disclosure would need to be made by all major NBFCs (Non Banking Finance Companies) on the stock exchange platform, irrespective of them being listed or unlisted entities, a senior official said.
Sebi is in the process of putting in place a necessary mechanism to ensure that all NBFCs, with asset size of Rs 100 crore and above, disclose to the stock exchanges about shares pledged with them.

The Sebi move follows a decision taken in this regard by the Reserve Bank, which has also taken steps to restrict the amount that NBFCs can lend against shares pledged with them.
In a widespread practice, NBFCs provide funds to the stock brokers, promoters of listed companies and stock market operators as 'margin funding' to help them trade in equities and make profits in lieu of commissions or profit-sharing.
As Sebi has put in place strict guidelines for margin funding by brokers, they generally involve friendly or related NBFCs (which may be part of same group) to provide such financing through 'unofficial' channels.

Margin funding typically involves an investor, trader or operator putting up a small part of the money required for the trade, while the lender provides the balance amount. There have been cases where NBFCs have provided margin funding of as high as 70-80 per cent.

While this 'unofficial' practice has been continuing for decades, it led to a sharp meltdown in share prices, especially of small and mid-cap companies, between 2011 and 2013 after NBFC financiers dumped the pledged shares following defaults by their borrowers.
In most cases, it was observed that such margin funding was provided by NBFCs unofficially and in violation of prudent lending practices. Many of them were suspected to have indulged in a 'pump and dump' practice of first luring the borrowers into pushing up the price and then dumping the pledged stocks to make twin profits -- by lending to traders as well as by trading in stocks.

Prior to RBI's crackdown in August this year, the lending against shares carried out by NBFCs was not subject to any specific instructions apart from general prudential norms.
"Irrespective of the manner and purpose for which money is lent against shares, default by borrowers can and has in the past lead to offloading of shares in the market by the NBFCs thereby creating avoidable volatility in the market.
"Certain other associated areas of concern relate to absence of adequate prior information to the stock exchanges on the shares held as pledge by NBFCs, probable overheating of the market, over-exposure by NBFCs to certain stocks and over-leveraging of borrowers," as per RBI.

The central bank had also said that there were "anecdotal evidences of volatility in the capital market being the result of offloading of shares by NBFCs" and therefore it was necessary to introduce a minimum set of guidelines on lending against shares.