The RBI has called for a closer examination of promoter share pledging, hinting that certain corporate practices of using multi-layered structures and pledging of shares to raise funds from the banking system could be a concern for the health of the financial system.
“In the case of a typical Indian company, the promoters pledge shares not for funding ‘outside’ business ventures but for the company itself. By pledging shares, the promoters have no personal liability other than to the extent of their pledged shares,” the RBI’s FSR report said.
“In some instances, shares pledged by unscrupulous promoters could go down in value and the promoters may not mind losing control of the company as there is a possibility of diversion of funds before the prices collapse… 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,” the report added.
The RBI said that pledging of shares is practiced in other advanced economies too, but it has taken a significantly different form in India. The FSR cited share pledging policy by Institutional Shareholder Services Inc (ISS) that ‘pledging of company stock in any amount as collateral for a loan is not a responsible use of equity’. ISS is the world’s leading corporate governance solution provider.
FE had earlier reported that share pledging rose to all-time high in the quarter ended September 30, 2014. Companies like ABG Shipyard, Jaiprakash Power and Pipavav Defence all have promoter-pledged holdings of upwards of 90%.