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Last Updated : Dec 03, 2019 05:44 PM IST | Source:

Lenders on thin ice as Karvy mess may expose due diligence failure

Also, norms for brokers and banks laid down by their respective regulators do not seem to be on the same page.

While lenders are facing chances of huge write-offs due to fraudulent activities of Karvy, it also likely that they skipped a few check-boxes themselves while lending against third party shares. Also, norms for brokers and banks laid down by their respective regulators do not seem to be on the same page.

While the Securities and Exchange Board of India (SEBI) has, on several occasions, tweaked norms to deal with misuse of clients' shares by brokers, lenders are still following the set of norms on extending loans against shares and debentures that were last revised in 2015.

"There seem to be clear lapses on part of banks as far as due diligence is concerned. SEBI had barred brokers from raising funds by pledging clients' shares this year and banking norms are also in place if such a facility was availed in the past. It's not clear whether banks followed these rules while lending and so their position seems to be problematic," said Bharat Chugh, Partner, L&L Partners.


On June 20, SEBI issued circular barring brokers from raising funds from banks as well as non-banks by pledging clients’ shares and ordered segregation and reporting of clients stocks and funds. Also, clients’ securities that are already pledged shall be unpledged by August 31, 2019, and returned to the clients after fulfilment of a pay-in obligation. These norms came into effect on September 1.

According to RBI's Master Circular that was last updated in July 2015, lenders can provide need-based overdraft facilities or lines of credit to brokers against shares and debentures held by them as stock-in-trade.

The RBI stated that banks should make a "careful assessment" of need-based requirements for such finance. This should be done by taking into account the financial position of the borrower, operations on his own account and on behalf of clients, income earned, the average turnover period of stocks and shares and the extent to which the broker's funds are required to be involved in the business operations.

Also, large scale investment in shares and debentures on own account by stock and share brokers with bank finance, should not be encouraged. RBI norms also stated that the securities lodged as collateral should be easily marketable.

"If it is prior to SEBI regulation kicking in, and banks have followed due diligence and registered charges on these shares with the depository, then they may have a right to these shares. But in a case where there are innocent investors on one side, it is likely that the judgement will be in their favour," Chugh added.

On December 2, nearly 90 percent of Karvy's clients got back their securities after National Securities Depository Ltd (NSDL) transferred the shares under directions from SEBI. Meanwhile, Karvy is under forensic audit initiated by NSE.

Bajaj Finance, which is one of the lenders, has moved the Securities Appellate Tribunal (SAT) contesting SEBI's decision to return the pledged shares to Karvy's clients. The matter is due to be heard on December 3.

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First Published on Dec 2, 2019 10:08 pm
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