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(Precious) Words of Wisdom : "Risk comes from not knowing what you’re doing." ~ Warren Buffett

Why has RBI made borrowing against shares more difficult?

Financial prudence demands that you should keep away from personal loans and also not create any credit card outstanding. As lenders do not have any underlying security against these advances, they charge you a higher rate of interest. Therefore ideally, whenever you need money, you should offer some security to the lender and pay comparatively much lower interest. [Read '11 Salient Features of Loan Against Securities']

Gold, insurance policies, fixed deposits, mutual funds and shares are among the varied assets against which you can avail your loans at highly competitive rates.

However, RBI has recently announced some restrictions on lending against shares by the Non Banking Finance Companies (NBFCs).

These are briefly discussed below.

1.  NBFCs lending against shares as a collateral would have to maintain a Loan-to-Value of 50%. Till now one could get a loan of as high as 70% of the value of shares.

2.  For loan amounts exceeding Rs.5 lakhs, only Group 1 securities would be acceptable. This list is issued by SEBI and updated from time to time.

3. NBFCs with asset size more than Rs.100 crores have to report to NSE / BSE the details of such shares pledged for extending loans to the borrowers. This is an online reporting facility.

On the face of it, these constraints may appear contradictory to advising people to opt for secured borrowing.

But there is a reason behind it.

On many occasions in the past, NBFCs have resorted to selling the pledged shares in the market as and when the borrowers have defaulted. And rightly so too. They have to protect their interest.

Unfortunately, this has often led to excessive volatility in the stock markets. And since the market is unaware of the reasons behind such massive sell-offs, an unwarranted fear is created in the market that leads to contagion effect. Above-mentioned restrictions, therefore, aim to curb this unnecessary overheating.

Secondly, in the absence of prudential limits on the loan amount, there is risk of both lenders getting over-exposed and the borrowers getting over-leveraged. This, naturally, adds to the panic.

As such RBI thought it wise to impose some minimum guidelines that protect the stock markets but at the same time allow genuine borrowers to access funds at lower rates.

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