Capping the fizz

Following up on its January discussion paper, Reserve Bank of India (RBI) is all set to transition India’s Non-Banking Finance Companies (NBFCs) to a new scale-based regulatory regime designed to reduce their arbitrage with banks. While most NBFCs consider it to be less onerous than originally feared, a brief provision tucked away in the regulations has set the cat amongst the pigeons for NBFCs financing stock market activity. RBI has sought to impose a per-borrower limit of ₹1 crore for NBFCs financing IPO applications, on the lines of the ₹10 lakh limit in place for banks. Market participants apprehend that, apart from depriving NBFCs of a sizeable opportunity, this rule could take the wind out of the sails of the high-flying primary market, by shrinking funds available to IPO investors, moderating over-subscription numbers and tempering listing gains. While the new rule may well have this effect, the fact is that it is in the best interests of the markets and must not be watered down.

IPO funding by NBFCs started off as a simple loan product where individuals looking to improve their chances of IPO allotment approached non-banks for short-term (5-7 day) loans that helped them bid in fancied offers. In recent times though, this has evolved into a high-stakes game where individual punters use highly leveraged NBFC funds to place outsized bids in the non-institutional quotas of IPOs (instead of the retail quotas) to beat proportionate allotment rules and cash out on listing. NBFCs betting big on this activity claim that the risks are minimal as they extend these loans for very short tenures, collect upfront margins and have lien on the allotted shares. But these safeguards aren’t fool-proof. With NBFCs in cut-throat competition, upfront margins on IPO funding have been whittled down to 1-2 per cent. With non-banks able to borrow funds at 4-5 per cent, interest rates on such loans have dropped to 7-8 per cent. While NBFCs offer these favourable terms based on optimistic assumptions on over-subscription numbers and listing gains, history has shown us that the stock market mood can go from euphoria to despair in short order. Should even a few IPOs list below offer price after adverse global or local events, investors taking these leveraged punts and NBFCs funding them may be forced to foot bunched-up losses, setting off an adverse chain reaction on systemic liquidity. Leveraged IPO bids also unfairly tilt the allotment process in favour of short-term punters, edging out genuine long-term investors and distorting price discovery.

While all this makes it quite prudent for RBI to place curbs on this activity, the only question is why the regulator has chosen to push the effective date of implementation to April 1, 2022. With a fat pipeline of IPOs set to hit the market in the next few weeks, the best time to check these excesses and make the primary market less frothy for long-term investors, is now.

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