Who got what from where

Trace most corporate investments to cheap investor money from the bull run

P.N. Vijay

The stockmarket crisis, which has gripped our bourses and is threatening to derail the economy, seems to bring out a new and unpleasant fact every day. For some time it looked as if it was a simple fight between bulls and bears, which has spilled outside on to the streets. However, like the ripples that come from a pond into which a stone has been thrown, the circles are growing larger and larger. A key issue to be debated in this regard is who is paying the piper? In other words, whose money are operators playing with?

It now transpires that the real financiers behind the operators are banks and companies. The banks have given money far in excess of what is prudent. This money has enabled operators to build large positions in the hope that these will go up in value. When the markets fell and the share prices did not go up they were caught on the wrong foot and the rest is well known.

One of the startling facts that has surfaced is that the banks have also not been reporting how much they have lent to operators. There appears to be heavy under-reporting in a novel way. For example, banks have lent funds keeping shares as collateral security. In these cases the primary security is not shares but something else. To illustrate, a Rs 100 crore advance would be given against security of a house or some business asset. This would obviously be far less than that required by bank regulations. And so the bank would take the shares as collateral.

It is a bit like the old Tenali Rama story where Emperor Krishna Deva Raya gifts him a horse and tells the court jester not to sell the horse. The smart man, who wants to sell the horse, goes and sells his cat instead for the price the horse would fetch him — and gives away the horse!

In the same way the bank would lend Rs 100 crore on Rs 5 crore of primary security and Rs 150 crore worth of shares as collateral. Furthermore, the advance does not appear in the bank books as one against shares and so, for reporting purposes, the banks outstandings against shares are far less than they would otherwise be. Needless to add, when the cookie crumbles, that advance tanks out.

Several suggestions have been made to stop this. Clearly, in addition to those, we need to ensure that the limits on advances should cover where market securities are held as Primary and Secondary.

Corporate money also appears to have gone into the market in a big way. If news reports are true, the Delhi-based Ranbaxy has lent huge resources to its own subsidiary, which then bought shares of Global Trust Bank. Nirma, the detergent manufacturer has bought shares, it appears, as a front for Ketan Parekh and his companies. There are now reports that Zee Telefilms has acquired Rs 220 crore worth of shares in other media companies. The latter are unlisted companies, Amitabh Bachchan’s AB Corp and a non-resident-Indian-owned owned B4U. It is quite possible that the shares were held by Ketan Parekh. There is also a report that B Arun Kumar, a leading diamond jeweller, had bought into the Bank of Madura through operators prior to the announcement of its merger with ICICI Bank.

It is essential that this type of funding of operators by banks and corporates is stopped. Bank finances to stock brokers should clearly be only for their working capital such as meeting expenses, buying capital assets, etc; in short, for a legitimate business activity. What we are finding is that bank finance finally ends up being used for trading and price manipulation by brokers.

There are limits under the Company’s Act on how much companies may invest or give in loans to other entities. However, this restriction alone may not be adequate since within that limit there is absolutely no check on what type of investment is made. Also, by routing the investment through a 100 per cent subsidiary, companies manage to get around these company law provisions.

Our regulators should put on their thinking caps to see how this loophole can be plugged. After all, if Zee is investing Rs 225 crore, and if one did a funds flow analysis, it would be seen that the money has finally come from investors and not from profits.

It is not an exaggeration to say that almost all corporate investments are traceable to cheap money got from investors during the bull phase. An operator is a very clever man and profit-hungry banks and aggressive companies would always like to fund him. Unfortunately the experience in India has been that this type of funding finally comes from investor or depositor money. And to that extent it needs to be protected.
P N Vijay is a Delhi-based investment banker.

He may be contacted through askpnvijay.com