Multi-layered structures, share pledging need to be examined, says RBI

Mumbai: With banks in India facing deteriorating asset quality, RBI today said certain corporate practices of using multi-layered structures and pledging of shares to raise funds from banking system need to be examined. In view of the prevalence of promoters pledging a substantial portion of their shares, the resultant leverage could be a concern not only for shareholders but also for the health of the financial system.  "This issue calls for a closer examination, especially in the current scenario of buoyancy in stock prices wherein the collateral in the form of pledged shares may appear to justify higher leverage." “In this regard, the fundamental question is one relate to implications from a company’s perspective of the practice wherein a company’s own shares can be pledged to raise debt on its balance sheet,” RBI said in its latest Financial Stability Report. Noting that the extent of restructured assets in the banking sector, especially public sector banks, is a cause of serious concern, RBI also voiced its concerns over repeated demands for regulatory forbearance from lenders, saying this creates a “moral hazard”. With regard to the leverages used by corporate borrowers, RBI said “in a typical double leveraging, a holding company raises debt on its balance sheet and infuses it as equity in SPVs. “From the lenders’ perspective, a debt-to-equity ratio of 2:1 at the holding company level could transform into a leverage of 8:1 at the SPV level. While there could be some merit in such practices, risk assessments by banks need to capture this effectively,” it added. About share pledging by promoters, RBI said a majority of Indian companies are family owned/controlled, as substantial levels of promoter shareholding are concentrated within the family. “The promoter shares can be significant collateral for a typical company if it wants to expand leverage. Pledging of shares is practiced in other advanced economies too, but it has taken a significantly different form in India. The report said growth in banking business and activity in primary capital markets remained subdued due to moderate investment intentions in the first half of FY15. It reiterated that sustaining the turnaround in business sentiment remains contingent on ground outcomes and added that significant new investments may take time to materialise. With the GDP clocking a growth of 5.3 percent in Q2, down from the preceding quarter’s 5.7 percent, RBI said the Q3 expansion is likely to be muted on a moderate kharif (monsoon crops) harvest. On the external front, the fall in global crude oil and commodity prices will help contain the current account deficit “but we must continue to be vigilant as capital inflows tend to be volatile,” the RBI said. PTI