HNIs use multiple-account route to bypass RBI’s Rs 1-crore limit on IPO funding by NBFCs

The RBI bars NBFCs from lending a borrower more than Rs 1 crore for an IPO.

High net-worth individuals (HNIs) have been routinely circumventing the Rs 1-crore limit set by the Reserve Bank of India for funding of initial public offerings (IPOs) by NBFCs, market sources told Moneycontrol. They have been doing that by opening multiple accounts with the non-banking finance companies (NBFCs), of which they are the ultimate beneficiary.

To curb the frenzy in the IPO market fuelled by money borrowed from NBFCs, the RBI imposed a ceiling of Rs 1 crore on the amount that NBFCs can lend a borrower for an issue, effective April 1, 2022.

It may have helped, to an extent, temper the previously massive subscriptions in the bigger sized IPOs but has done little to dampen the craze for IPOs of small and micro (SME) enterprises.

Moneycontrol spoke to some of the HNIs who invest in IPOs using borrowed funds and this is how the “system” operates:

HNIs open multiple accounts with the NBFC in the name of family members, their firms, family offices, trusts and even employees.

IPO funding requires the client to put up a certain amount as margin. This may vary between 1 and 10 percent; depending on how many times the NBFC expects the issue to be oversubscribed. Lower the subscription, higher is the margin collected from the clients. Conversely, the margin collected is lower if the issue is expected to see heavy subscription.

Reason being, higher the number of times the issue is subscribed, lesser the number of shares that will be allotted to applicants. So a lower upfront margin will be enough to cover any potential downside if the IPO flops on listing.

Say the client has put up a margin of Rs 50,000 and is allotted shares worth Rs 2 lakh, the NBFC is covered even if the stock falls 20 percent on listing.

The standard procedure for IPO financing is that the NBFC has control over the client’s bank account and demat account through power of attorney (PoA) agreements. This arrangement minimises the risk for NBFCs, which is why many of them are keen on IPO financing as it is a lucrative source of funding with minimum risks.

The LAP route

After opening multiple accounts, the HNIs then avail loan against shares (LAS) or loan against property (LAP) from the same NBFC. There is nothing illegal in this because the loans are backed by collateral.

The funds are then routed into multiple accounts towards the upfront margin, and each of those account then apply for IPO funding.

“On the face of it, this is not illegal because each of the accounts are separate entities,” said an HNI. “But in majority of the cases, the NBFC is aware that money is ultimately going to the same client. That makes a mockery of the RBI rule, which was put in place to reduce use of NBFC funding in IPOs,” the HNI said on condition of anonymity.

Disclosures

Even where the loans are given out against shares or property, NBFCs seek an undertaking from clients on the end use of funds.

“If they are using it to repay loans, we ask for the bank statements and if they are using it for investments, we ask for proof for that as well,” said an official at one of the top five NBFCs.

But industry players say that in practice, this rule is not enforced in the case of IPO funding because of the short-term nature of the funding.

Likely rule changes

NBFC and stock market players feel two rules could become tighter in the light of the recent strictures passed by the RBI against IIFL Finance and JM Financial.

One is that the RBI may get stricter about the upfront margin that NBFCs collect from clients for IPO financing. At present, it is at the discretion of the NBFC, based on its relationship with the clients and its assessment of the client’s financial situation.

Two, the RBI may also take a much harsher view if there is an obvious discrepancy between the stated end use of funds and for the purpose it has been deployed for.

“NBFCs cannot always monitor the end use of funds by clients, but at least it could reduce instances where NBFCs willing turn a blind eye for their own gains,” the NBFC official said.