Here's how HNIs bypass RBI's Rs 1 crore limit on IPO funding by NBFCs

The high net worth Individuals (HNI) have been bypassing the Reserve Bank of India's Rs 1 crore limit on IPO funding by NBFCs, reported Moneycontrol quoting a market source. According to the report, they have been doing that by opening multiple accounts with the non-banking finance companies (NBFCs).

The Reserve Bank of India has imposed a ceiling of Rs 1 crore on the amount that NBFCs can lend a borrower for an issue to control the IPO market frenzy fuelled by the NBFCs

HNIs Modus Operandi

The HNIs who use borrowed funds to buy IPOs, first open multiple accounts in Non Banking Financial Corporations (NBFC) in the name of family members, their firm, family office and even employees.

NBFCs are also keen on IPO financing as they get control over the client’s bank account and demat account through power of attorney (PoA) agreements. This arrangement minimises the risk for NBFCs.

After opening multiple accounts, the HNIs avail loan against share (LAS) or loan against property (LAP) from the same NBFC. As the loans are taken against a collateral there is nothing illegal in this.

The funds are then directed to the 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,” a HNI told Moneycontrol.

The NBFCs also collect certain amount from the clients as a margin. Depending on how many times the NBFC expects the issue to be oversubscribed the margin may vary between 1 and 10%.

Lower the subscription, higher is the margin collected from the clients and vice versa. This is because, 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.

NBFCs also seek an undertaking from clients on the end use of funds even for the loans that were taken against shares or property.

“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 to Moneycontrol.

However, this rule is not enforced in the case of IPO funding because of the short-term nature of the funding.

Change in rules likely

In light of the recent crackdown on IIFL Finance and JM Financial by the RBI, Moneycontrol reported that two rules could be made tighter. As per the Moneycontrol report, 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.

The Reserve Bank of India 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.