RBI, Sebi roil stock market with new crackdowns on IPO financing, gold

Shadow banks have become the latest target, after the Reserve Bank of India this week limited lending by firms including JM Financial Products Ltd. The measures come after the banking regulator barred an affiliate of fintech giant Paytm from accepting fresh deposits, while the capital markets watchdog urged mutual fund sellers to safeguard investors against excessive froth in small-cap stocks.

More such moves may be on the cards as the completes inspections of some major non-banks engaged in equity markets financing, according to people familiar with the regulator’s thinking. The central bank had set up a separate team of professionals for bank supervision, which has become more detailed and comprehensive, said the people, who asked not to be identified discussing private matters.

“We expect more such steps in other parts of the credit funnel,” said Pranav Bhavsar of India Independent Insight, who publishes on Smartkarma. He said the recent crackdown and hit to some shadow bank stocks “is here to stay and possibly intensify.”

RBI didn’t respond to an email seeking comment about the recent crackdowns.

India is booming on all fronts, and regulators are trying to remove some exuberance from the financial system while ensuring banks and other players have a better handle on potential risks. The economy is growing at more than 6%, and demand for loans and IPOs are soaring. Stocks keep rising, after eight straight years of gains.

The RBI has been warning financial services firms to improve their governance and risk assessment systems for months. Even though bad debts are at a more than a decade low, the regulator has clamped down on unsecured lending and asked banks to make more provisions for other loans. Officials are also warning about lapses in customer verification to guard against potential fraud and money laundering.

In January, the Securities and Exchange Board of India Chairwoman Madhabi Puri Buch spoke about her concerns. “We are unhappy about some of the malpractices that we see,” she said, referring to mule accounts and inflation of application numbers. “We now have the data and we will act.”

Banks, shadow lenders and fintech players are all feeling the heat.

JM Financial’s shares tumbled as much as 20% on Wednesday — the limit imposed by the exchange — and the biggest intraday slide in four years, dragging down other financial stocks. Shares in IIFL Finance Ltd., another shadow lender facing RBI scrutiny, plunged by the 20% limit in each of the last two sessions. Both stocks have since recovered some losses.

Paytm is still down more than 40% since its banking affiliate was barred from adding deposits after people familiar with the matter said it failed to properly vet hundreds of thousands of clients.

“More instances of such actions could create an overhang” on shadow bank stocks, Morgan Stanley analysts wrote in a report.

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The latest move on shadow banks targets asset-backed lending, a source of revenue for these firms. The central bank barred JM Financial from extending loans against shares and bonds after an inspection revealed serious deficiencies in financing IPOs and bond offerings, according to a statement Tuesday. IIFL Finance meanwhile was asked to stop sanctioning or disbursing gold loans after the RBI found “material supervisory concerns” in its portfolio.

JM Financial said in a statement that it hasn’t violated applicable regulations, and will co-operate with the RBI. The company’s financial products unit hasn’t found any “material deficiencies” in its loan processes. The IPO financing business contributed just 0.3% of the parent company’s profit for the nine-month period ended in December, the firm said.

IIFL had said it is committed to comply with the RBI findings.

Shadow lenders like IIFL and JM Financial are important for the expansion of credit in the world’s most-populous country. They typically serve clients outside the main bank network, including small businesses with unpredictable cash flow.

IPO Drive

The restrictions on shadow bank lending may spill over to the IPO market, which has been booming even as sales slump elsewhere. This year and next will be the busiest “in our lifetime,” according to one Bank of America Corp. executive in India.

The shadow banks are important drivers because they lend to individual investors keen to snap up the latest hot listing. That retail push often results in massive oversubscriptions, prompting a warning by the capital markets regulator of potential inflated applications that overstate demand.

In addition to lending, JM Financial and IIFL have underwritten many of these deals. IIFL ranked third for India equity offerings last year, while JM ranked sixth, both ahead of global firms like Morgan Stanley and Goldman Sachs Group Inc., according to data compiled by Bloomberg.

RBI’s action “will dampen the IPO funding market and you may not see astronomical listing-day gains for some time,” said Amit Kumar Gupta, founder at Fintrekk Capital. Nevertheless, “such surveillance is required” he said, noting that the restrictions won’t impact the broader market.
Limits on gold lending will likely hurt IIFL, as these loans accounted for almost a third of its 774 billion rupees ($9.3 billion) portfolio as of December, according to a company presentation. In India, gold jewelry is used as collateral for bank loans by borrowers who typically have a low credit score and need liquidity for a shorter period.

RBI is also cracking down on loans backed by stocks, a robust business for shadow lenders. In a January conference call, Bajaj Finance Ltd.’s top executive Rajeev Jain told investors that such lending is limited to wealthy clients but it is “an area of growth from an opportunity standpoint.”

The current challenges notwithstanding, at least one shareholder is keeping its faith with the shadow lenders. Two days after RBI’s action against IIFL, Fairfax Financial Holdings Ltd. — its largest shareholder — committed $200 million for liquidity support.

“We have been long-term investors in the IIFL group of companies and have full trust and confidence in the company’s strong management team,” said Prem Watsa, the billionaire founder of Canadian insurer Fairfax.