RBI to prescribe 25% margin on IPO financing - Views on News from Equitymaster

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RBI to prescribe 25% margin on IPO financing

Feb 26, 2000

The Reserve Bank of India is expected to fix a minimum lending margin of 25% for banks funding initial public offerings (IPO). This stance will cap financing of new issues by banks to the extent of 75% of the share application amount. Currently there is no stipulation on IPO financing and banks are fixing margins and exposures to IPOs based on their own internal norms. The RBI is expected to set up a panel to frame prudential guidelines on IPO financing to cover all banks. These guidelines are expected to be announced in the April credit policy.

This moves stems from the recent review of RBI on IPO financing of banks. Many banks are apparently extending IPO loans at margins much below the industry standards. Some banks are currently funding IPOs at margins as low as 10%, while margin against physical and demat shares is around 25%-30%.

Banks have become active in financing IPOs recently and this has resulted in new issues getting oversubscribed by many times. Also this avenue has become a comfortable route for banks to deploy their funds at higher rates of interest. The reason for charging margins below the industry standard can be attributed to stiff competition among banks for IPO financing.

This entire process of applying by leveraging is based on the premise that on listing the issue would open at a higher price (high enough to cover the cost of financing) than the issue price. However if this does not happen and it gets listed below the issue price, then investors have to bear the burden of this loss coupled with the cost of financing of the issue.

Hence RBI is framing these norms as it appears to be concerned on the following issues:

  • As IPO market continues to boom, it will attract low quality companies to raise money.
  • Investors who have taken loan to apply these issues may not be able to repay there loans if the issue were to fail on listing. As the paper of the issue itself is held as collateral banks would also find it difficult to liquidate and recover the loan.

In order to avoid such an eventuality RBI is taking these preventive measures. It would not like to see the health of the banking system weaken again by bad loans as happened in 1992 stock market scam and the 1994 IPO market crash.

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