The Reserve Bank of India on Friday issued a fresh set of rules for non-banking finance companies (NBFCs), one of which limits lending to IPO investors to Rs 1 crore per borrower from April 1, 2022. Till now, some high net worth individuals have been borrowing in excess of Rs 100 crore, from NBFCs for investing in IPOs. That will not be possible once the new RBI rule becomes effective next year.

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Why has the RBI come out with this rule?

The rule to cap IPO funding by NBFCs, along with other rules on capital and bad loan provisioning norms in a phased manner, is part of RBI’s broader efforts to reduce risks in the financial sector.

How does IPO funding work?

At present, NBFCs are offering anywhere between 70-100 times leverage to rich investors looking to take short-term bets on IPOs. What this means is that if the investor puts Rs 1 crore of his/her own, the NBFC will lend anywhere between Rs 70 crore to Rs 100 crore for seven days—the time from subscription till issue listing. The interest rate for such funding varies between 7 and 8 percent.

On listing day, the shares are sold as soon as trading starts, and the money goes back to the NBFC.

Isn’t this a risky affair for NBFCs?

Not really. Because the NBFC has the power of attorney (PoA) to both the trading account (in which the shares will be credited) and the bank account (in which the proceeds from the share sale will be credited). The NBFC will take back its funds plus an interest charge, and what is left in the bank account is the investor’s profit/loss. Even if the shares list at a steep loss, the NBFC will not lose any money because the investor has put up 1 percent of his own capital. Losses if any, will be recovered from the investor’s funds.

Wow..so it is risk-free money for NBFCs?

Again, not really. In August this year, SEBI had barred 15 entities from the market after finding them guilty of insider trading. To recover the ill-gotten gains, SEBI ordered the freezing of the bank accounts of the entities. Among the bank accounts frozen were those which had been opened for borrowing funds from NBFCs for IPO financing. As a result of the freeze, Rs 1200 crore of Bajaj Finance’s funds got stuck.

What implication will the RBI rule have for upcoming IPOs?

IPOs scheduled between now and March 31 will not be affected by the rule. For IPOs from April 1 onwards, subscriptions numbers for the non-institutional investor (HNIs in market parlance) category could be much lower.

Is that a bad thing?

Depends on how you look at it. Because there are no limits on IPO financing right now, and funds are cheap, wealthy investors bid for outsized quantities. That results in the non-institutional investor category getting subscribed multiple times. That gives a distorted picture of demand to retail investors looking to invest in the issue. Within the NII category, those who bid aggressively have a better shot at the allotment, compared to somebody who may not be able to bid aggressively.

Will the new rule hit demand for IPOs from rich investors?

Depends on whether the investors are able to find a workaround. For instance, the rule limits NBFCs from lending more than Rs 1 crore per investor. It does not mean that the investor cannot borrow from other NBFCs. Also, it does not prevent the investor from applying for IPOs through multiple accounts. If the RBI specifies that an investor who has borrowed from one NBFC for IPO investing, cannot borrow from other NBFCs for the same purpose, it could affect demand.

What about the implications for NBFCs?

NBFCs that earn a sizeable portion of their revenues through IPO financing could take a hit on their bottom line next year. That is assuming the IPO market remains buoyant even then. Investors can figure ways to get around the RBI rule, but it won’t be as easy for NBFCs, who risk falling foul of the regulator.

(Edited by : Ajay Vaishnav)