(iii) The exposure of banks to entities for setting up Special Economic Zones (SEZs) or for acquisition of units in SEZs which includes real estate would be treated as exposure to commercial real estate sector and banks would have to make provisions as also assign appropriate risk weights for such exposures as per the existing guidelines.
(iv) While framing the bank's policy, the guidelines issued by the Reserve Bank should be taken into account. Banks should ensure that the bank credit is used for productive construction activity and not for any activity connected with speculation in real estate.
3.2 Exposure to Leasing, Hire Purchase and Factoring Services
3.2.1 Banks should maintain a balanced portfolio of equipment leasing, hire purchase and factoring services vis-à-vis the aggregate credit. Their exposure to each of these activities should not exceed 10 percent of total advances.
3.3 Exposure to Indian Joint Ventures/Wholly-owned Subsidiaries Abroad
3.3.1 Banks are allowed to extend credit/non-credit facilities (viz. letters of credit and guarantees) to Indian Joint Ventures/Wholly-owned Subsidiaries abroad. Banks are also permitted to provide at their discretion, buyer's credit/acceptance finance to overseas parties for facilitating export of goods & services from India.
3.3.2 The above exposure will, however, be subject to a limit of 10 percent of banks’ unimpaired capital funds (Tier I and Tier II capital), subject to the following conditions:
i. Loan will be granted only to those joint ventures where the holding by the Indian company is more than 51%.
ii. Proper systems for management of credit and interest rate risks arising out of such cross border lending are in place.
iii. While extending such facilities, banks will have to comply with Section 25 of the Banking Regulation Act, 1949, in terms of which the assets in India of every banking company at the close of business on the last Friday of every quarter shall not be less than 75 percent of its demand and time liabilities in India. In other words, aggregate assets outside India should not exceed 25 percent of the bank's demand and time liabilities in India.
iv. The resource base for such lending should be funds held in foreign currency accounts such as FCNR(B), EEFC, RFC, etc. in respect of which banks have to manage exchange risk.
vi. Maturity mismatches arising out of such transactions are within the overall gap limits approved by RBI.
vii. All existing safeguards / prudential guidelines relating to capital adequacy, exposure norms etc. applicable to domestic credit / non-credit exposures are adhered to.
Further, the loan policy for such credit / non-credit facility should be, inter alia, in keeping with the following:
(a) Grant of such loans is based on proper appraisal and commercial viability of the projects and not merely on the reputation of the promoters backing the project. Non-fund based facilities should be subjected to the same rigorous scrutiny as fund-based limits.
(b) The countries where the joint ventures / wholly owned subsidiaries are located should have no restrictions applicable to these companies in regard to obtaining foreign currency loans or for repatriation, etc. and should permit non-resident banks to have legal charge on securities / assets abroad and the right of disposal in case of need.
3.3.3 Banks should also comply with all existing safeguards/prudential guidelines relating to capital adequacy, and exposure norms indicated in paragraph 2.1, ibid.
3.4 Banks’ Exposure to Capital Market
The salient features of the guidelines on banks' financing against shares, debentures, etc. are given below:
3.4.1 Statutory Limit on Shareholding in Companies
In terms of Section 19(2) of the Banking Regulation Act, 1949, no banking company shall hold shares in any company, whether as pledgee, mortgagee or absolute owner, of an amount exceeding 30 percent of the paid-up share capital of that company or 30 percent of its own paid-up share capital and reserves, whichever is less, except as provided in sub-section (1) of Section 19 of the Act. Shares held in demat form should also be included for the purpose of determining the exposure limit. This is an aggregate holding limit for each company. While granting any advance against shares, underwriting an issue of shares, or acquiring any shares on investment account or even in lieu of debt of any company, these statutory provisions should be strictly observed.
3.4.2 Regulatory Limits
Banks’ aggregate exposure to the capital market covering direct investment in equity shares, convertible bonds and debentures, units of equity oriented mutual funds; and all exposures to Venture Capital Funds (VCFs) [both registered and unregistered], advances against shares to individuals for investment in equity shares (including IPOs / ESOPs ), bonds and debentures, units of equity-oriented mutual funds etc. and secured and unsecured advances to stockbrokers and guarantees issued on behalf of stockbrokers and market makers; should not exceed 5 percent of their total outstanding advances (including Commercial Paper) as on March 31 of the previous year. This ceiling of 5 percent prescribed for investment in shares would apply to total exposure including both fund based and non-fund based exposure to capital market in all forms. Within this overall ceiling, banks’ investment in shares, convertible bonds and debentures, units of equity-oriented mutual funds and all exposures to Venture Capital Funds (VCFs) [both registered and unregistered] should not exceed 20 percent of their networth. The banks are required to adhere to this ceiling on an ongoing basis.
The ceiling on exposure to capital market should be computed with reference to sanctioned limits or outstandings, whichever is higher. Further, direct investment in shares by banks should be calculated at cost price of the shares.
3.4.3 Advances against Shares to Individuals
Loans against the security of shares, debentures and PSU bonds to individuals should not exceed the limit of Rs. 10 lakh per individual borrower if the securities are held in physical form and Rs 20 lakhs per individual borrower, if the securities are held in demat form. The banks can grant advances to employees for purchasing shares of their own companies under Employees Stock Option Plan(ESOP) to the extent of 90% of the purchase price of shares or Rs. 20 lakh, whichever is lower. Further, banks can extend loans upto Rs.10 lakh to individuals for subscribing to Initial Public Offerings (IPOs). Finance extended by a bank for IPOs/ESOPs will be reckoned as an exposure to capital market and included within the ceiling indicated in para 3.4.2 above. Advances against units of mutual funds including units of Unit-64 scheme would attract the quantum and margin requirements as are applicable to advances against shares and debentures. However, the quantum and margin requirement for loans/ advances to individuals against units of exclusively debt-oriented mutual funds may be decided by individual banks themselves in accordance with their loan policy.
3.4.4 Banks should formulate with the approval of their Boards, the Lending Policy for grant of advances to individuals against shares, debentures, bonds keeping in view RBI guidelines. As a prudential measure, the banks may also consider laying down appropriate aggregate sub-limits for such advances.
3.4.5 Advances against Shares to Stockbrokers and Market Makers
Banks are free to provide credit facilities to stockbrokers and market makers on the basis of their commercial judgment, within the policy framework approved by their Boards. However, in order to avoid any nexus emerging between inter-connected stock broking entities and banks, the Board of each bank should fix, within the overall ceiling of 5 percent of their total outstanding advances (including Commercial Paper) as on March 31 of the previous year, a sub-ceiling for total advances to –
i. all the stockbrokers and market makers (both fund based and non-fund based, i.e. guarantees); and
ii. to any single stock broking entity, including its associates/ inter-connected companies.
3.4.6 Margins on advances against shares / issue of guarantees
A uniform margin of 50 percent shall be applied on all advances / financing of IPOs/issue of guarantees. A minimum cash margin of 25 percent (within the margin of 50%) shall be maintained in respect of guarantees issued by banks for capital market operations.
3.4.7 Arbitrage operations
Banks should not undertake arbitrage operations themselves or extend credit facilities directly or indirectly to stockbrokers for arbitrage operations in Stock Exchanges. While banks are permitted to acquire shares from the secondary market, they should ensure that no sale transaction is undertaken without actually holding the shares in its investment account.
3.4.8 Margin Trading
Banks may extend finance to stockbrokers for margin trading in actively traded scrips, forming part of the NSE Nifty and the BSE Sensex, within the overall ceiling of 5% prescribed for exposure of banks to capital market.
3.5 Bank Loans for Financing Promoters' Contributions
3.5.1 Loans sanctioned to corporates against the security of shares (as far as possible, demat shares) for meeting promoters' contribution to the equity of new companies in anticipation of raising resources, should be treated as a bank’s investments in shares which would thus come under the ceiling of 5 percent of the bank's total outstanding advances (including Commercial Paper) as on March 31 of the previous year prescribed for the bank’s total exposure including both fund based and non-fund based to capital market in all forms.
3.5.2 These loans will also be subject to individual/group of borrowers exposure norms as well as the statutory limit on shareholding in companies, as detailed above.
3.5.3 In the context of Government of India’s programme of disinvestments of its holdings in some public sector undertakings (PSUs), it has been clarified to banks that they can extend finance to the successful bidders for acquisition of shares of these PSUs, subject to certain conditions. If on account of banks’ financing acquisition of PSU shares under the Government of India’s disinvestment programmes, any bank is likely to exceed the regulatory ceiling of 5 percent on capital market exposure in relation to its total outstanding advances as on March 31 of the previous year, such requests for relaxation of the ceiling would be considered by RBI on a case by case basis, subject to adequate safeguards regarding margin, bank’s exposure to capital market, internal control and risk management systems, etc. The relaxation would be considered in such a manner that the bank’s exposure to capital market, in all forms, net of its advances for financing of acquisition of PSU shares shall be within the regulatory ceiling of 5 percent. RBI would also consider relaxation on specific requests from banks in the individual / group credit exposure norms on a case-by-case basis (in the format prescribed in terms of circular DBOD No. BP. 2724/21.03.054/2000-01 dated 28 May 2001), provided that the bank’s total exposure to the borrower, net of its exposure due to acquisition of PSU shares under the Government of India disinvestments programme, should be within the prudential individual / group borrower exposure ceiling prescribed by RBI.
3.5.4 Under the refinance scheme of Export Import Bank of India (EXIM Bank), banks may sanction term loans on merits for eligible Indian promoters for acquisition of equity in overseas joint ventures/ wholly owned subsidiaries, provided the term loans have been approved by the EXIM Bank for refinance. Further, banks may extend financial assistance to Indian companies for acquisition of equity in overseas joint ventures/wholly-owned subsidiaries or in other overseas companies, new or existing, as strategic investment, in terms of a Board approved policy, duly incorporated in the loan policy of the bank. Such policy should include overall limit on such financing, terms and conditions of eligibility of borrowers, security, margin, etc.
3.6 Risk Management and Internal Control System
Banks desirous of making investment in equity shares / debentures, financing of equities and issue of guarantees within the above ceiling, should observe the following guidelines:
a) Investment policy
(i) Formulate a transparent policy and procedure for investment in shares, etc., with the approval of the Board.
(ii) The banks should build up adequate expertise in equity research by establishing a dedicated equity research department, wherever warranted by their scale of operations.
b) Investment Committee
The decision in regard to direct investment in shares, convertible bonds and debentures should be taken by an Investment Committee set up by the bank’s Board. The Investment Committee should be held accountable for the investments made by the bank.
c) Risk Management
(i) Banks should ensure that their exposure to stockbrokers is well diversified in terms of number of broker clients, individual inter-connected broking entities;
(ii) While sanctioning advances to stockbrokers, banks should take into account the track record and credit worthiness of the broker, financial position of the broker, operations on his own account and on behalf of clients, average turnover period of stocks and shares, the extent to which the broker’s funds are required to be involved in his business operations, etc;
(iii) While processing proposals for loans to stockbrokers, banks are also advised to obtain details of facilities enjoyed by the broker and all his connected companies from other banks;
(iv) While granting advances against shares and debentures to other borrowers, banks should obtain details of credit facilities availed by them or their associates/inter-connected companies from other banks for the same purpose (i.e. investment in shares, etc.) in order to ensure that high leverage is not built up by the borrower or his associate or inter-connected companies with bank finance.
3.6.1 Audit committee
(i) The surveillance and monitoring of investment in shares / advances against shares shall be done by the Audit Committee of the Board, which shall review in each of its meetings, the total exposure of the bank to capital market, both fund based and non-fund based, in different forms and ensure that the guidelines issued by RBI are complied with and adequate risk management and internal control systems are in place;
(ii) The Audit Committee shall keep the Board informed about the overall exposure to capital market, the compliance with RBI and Board guidelines, adequacy of risk management and internal control systems;
(iii) In order to avoid any possible conflict of interest, it should be ensured that the stockbrokers as directors on the Boards of banks or in any other capacity, do not involve themselves in any manner with the Investment Committee or in the decisions in regard to making investments in shares, etc., or advances against shares.
3.6.2 Valuation and Disclosure
Equity shares in a bank’s portfolio - as primary security or as collateral for advances or for issue of guarantees and as an investment - should be marked to market preferably on a daily basis, but, at least on a weekly basis. Banks should disclose the total investments made in equity shares, convertible bonds and debentures and units of equity oriented mutual funds as also aggregate advances against shares in the ‘Notes on Account’ to their balance sheets.
3.7 Bridge Loans
3.7.1 Banks have been permitted to sanction bridge loans to companies for a period not exceeding one year against expected equity flows/issues. Such loans should be included within the ceiling of 5 percent of the banks’ total outstanding advances (including Commercial Paper) as on March 31 of the previous year prescribed for total exposure, including both fund-based and non-fund based exposure to capital market in all forms.
3.7.2 Banks should formulate their own internal guidelines with the approval of their Board of Directors for grant of such loans, exercising due caution and attention to security for such loans.
3.7.3 Banks may also extend bridge loans against the expected proceeds of Non-Convertible Debentures, External Commercial Borrowings, Global Depository Receipts and/or funds in the nature of Foreign Direct Investments, provided the banks are satisfied that the borrowing company has already made firm arrangements for raising the aforesaid resources/funds.
3.8 Bank finance to employees to buy shares of their own companies
Banks may provide finance to assist employees to buy shares of their own companies under Employee Stock Option Plans (ESOPs) to the extent of 90% of the purchase price of the shares or Rs. 20 lakh, whichever is lower. However, all such financing should be treated as part of the banks’ exposure to capital market within the overall ceiling of 5 percent of banks’ total outstanding advances, as on March 31 of the previous year. These instructions, however, will not be applicable to banks’ extending financial assistance to their own employees for acquisition of shares under ESOPs/ IPOs. Banks therefore should not extend advances, including advances to their employees / Employee Trusts set up by them, for the purpose of purchasing their (banks’) own shares under ESOP / IPO or from the secondary market. This prohibition will apply irrespective of whether the advances are unsecured or secured.
4. Exposure Norms for Investments
4.1 Ceiling on overall exposure to capital market
Banks' exposure to capital market as detailed in paragraph 3.4.2 above, should be within the overall ceiling of 5 percent of the banks total outstanding advances (including Commercial Paper) as on March 31 of the previous year. Within this overall ceiling, banks' investment in shares, convertible bonds and debentures and units of equity-oriented mutual funds should not exceed 20 percent of their net worth. The banks are required to adhere to the ceiling on an ongoing basis and should exercise care to see that the limit is not exceeded.
4.1.1 For the purpose of reckoning compliance with the ceiling for investments prescribed above, the following items are to be included –
i. direct investment by a bank in equity shares, convertible bonds and debentures and units of equity oriented mutual funds, the corpus of which is not exclusively invested in corporate debt.
ii. bank finance for financing promoters' contribution towards equity capital of new companies.
iii. bridge loans to companies.
4.1.2 The investment ceiling excludes investment in -
i. the subordinated debts of other banks,
ii. preference shares,
iii. non-convertible debentures/bonds of private corporate bodies,
iv. equities/bonds of All-India Financial Institutions
(as per list given in Annexure 3),
v. bonds issued by Public Sector Undertakings,
vi. units of Mutual Funds under schemes where the corpus is invested exclusively in debt instruments, and
vii. investments in Certificate of Deposits (CDs) of other banks/ financial institutions.
4.1.3 However, all these categories of investments are to be taken into consideration for the purpose of arriving at the prudential norm of credit exposure for single borrower and group of borrowers, as stipulated in paragraph 2.1 above.
4.1.4 Banks' Investment in the Bonds of a Corporate
For the purpose of calculation of exposure norm, investments made by banks in bonds and debentures of corporates, which are guaranteed by a PFI, as per the list given in Annexure 2, will be treated as an exposure by the banks on the PFI and not on the corporate.
4.1.5 Guarantees issued by the PFI to the bonds of corporates will be treated as an exposure by the PFI to the corporates to the extent of 50 percent, being a non-fund facility, whereas the exposure of the bank on the PFI guaranteeing the corporate bond will be 100 percent. The PFI before guaranteeing the bonds/debentures should, however, take into account the overall exposure of the guaranteed unit to the financial system.
4.1.6 Cross holding of capital among banks / financial institutions
i. Banks' / FIs' investment in the following instruments, which are issued by other banks / FIs and are eligible for capital status for the investee bank / FI, should not exceed 10 percent of the investing bank's capital funds (Tier I plus Tier II)
a. Equity shares;
b. Preference shares eligible for capital status;
c. Subordinated debt instruments;
d. Hybrid debt capital instruments; and
e. Any other instrument approved as in the nature of capital.
ii. Banks / FIs should not acquire any fresh stake in a bank's equity shares, if by such acquisition, the investing bank's / FI's holding exceeds 5 percent of the investee bank's equity capital.
2. Banks’ / FIs’ investments in the equity capital of subsidiaries are at present deducted from their Tier I capital for capital adequacy purposes. Investments in the instruments issued by banks / FIs which are listed at paragraph 4.1.6 (i) above, which are not deducted from Tier I capital of the investing bank/ FI, will attract 100 percent risk weight for credit risk for capital adequacy purposes.
4.1.7 Banks’ Investment in Venture Capital Funds (VCFs)
All exposures of banks to VCFs (both registered and unregistered) will be deemed to be on par with equity and hence will be reckoned for compliance with the capital market exposure ceilings (ceiling for direct investment in equity and equity linked instruments as well as ceiling for overall capital market exposure).
4.2 Underwriting of Corporate Shares and Debentures
Generally, there are demands on the banks for underwriting the issues of shares and debentures. In order to ensure that there is no over exposure to underwriting commitments to earn fees, the guidelines detailed below should be strictly adhered to:
i. The statutory provisions contained in Section 19(2) & (3) of the Banking Regulation Act, 1949, regarding holding of shares in any company as pledgee / mortgagee or absolute owner, should be strictly adhered to.
ii. Banks have to ensure that the shares/debentures including PSU equities and shares of other banks, Mutual Funds (the corpus of which is not exclusively invested in corporate debt instruments), the units of UTI subscribed and/or devolving on them as a part of their underwriting obligations in any particular year, comply with the ceiling prescribed for the banks’ exposure to the capital markets.
iii. It may be noted that the limit placed is on the shares and debentures that may be held in the banks' own portfolio as a result of devolvement and not on the amount of underwriting that the banks may engage in. Normally, the amount of underwriting is a multiple of the amount which devolves finally.
iv. The underwriting exposure will be a part of the overall exposure and subject to the limit laid down in paragraphs 2.1 above. While taking up underwriting commitments, banks or their subsidiaries, should ensure that the aggregate of such commitments are included in the exposure limits fixed by the Reserve Bank.
v. In the case of underwriting, the commitments under a single obligation should be fixed taking into account the owned funds of banks and the capacity to meet the commitments that may devolve and should not, in any case, exceed 15 percent of an issue.
4.3 Other matters on Underwriting Operations
Regarding all other matters concerning underwriting, banks may be guided by the Master Circular on Para Banking Activities.
4.4 'Safety Net' Schemes for Public Issues of Shares, Debentures, etc.
4.4.1 'Safety Net' Schemes
Reserve Bank had observed that some banks/their subsidiaries were providing buy-back facilities under the name of ‘Safety Net’ Schemes in respect of certain public issues as part of their merchant banking activities. Under such schemes, large exposures are assumed by way of commitments to buy the relative securities from the original investors at any time during a stipulated period at a price determined at the time of issue, irrespective of the prevailing market price. In some cases, such schemes were offered suo motto without any request from the company whose issues are supported under the schemes. Apparently, there was no undertaking in such cases from the issuers to buy the securities. There is also no income commensurate with the risk of loss built into these schemes, as the investor will take recourse to the facilities offered under the schemes only when the market value of the securities falls below the pre-determined price. Banks/their subsidiaries have therefore been advised that they should refrain from offering such ‘Safety Net’ facilities by whatever name called.
4.4.2 Provision of buy back facilities
In some cases, the issuers provide buy-back facilities to original investors up to Rs. 40,000/- in respect of non-convertible debentures after a lock-in-period of one year, to provide liquidity to debentures issued by them. If, at the request of the issuers, the banks or their subsidiaries find it necessary to provide additional facilities to small investors subscribing to new issues, such buy-back arrangements should not entail commitments to buy the securities at pre-determined prices. Prices should be determined from time to time, keeping in view the prevailing stock market prices for the securities. Commitments should also be limited to a moderate proportion of the total issue in terms of the amount and should not exceed 20 percent of the owned funds of the banks/their subsidiaries. These commitments will also be subject to the overall exposure limits which have been or may be prescribed from time to time.
5. Limits on exposure to unsecured guarantees and unsecured advances
The instruction that banks have to limit their commitment by way of unsecured guarantees in such a manner that 20 percent of the bank’s outstanding unsecured guarantees plus the total of outstanding unsecured advances do not exceed 15 percent of total outstanding advances has been withdrawn to enable banks’ Boards to formulate their own policies on unsecured exposures. Simultaneously, all exemptions allowed for computation of unsecured exposures also stand withdrawn.
With a view to ensuring uniformity in approach and implementation, ‘unsecured exposure’ is defined as an exposure where the realisable value of the security, as assessed by the bank /approved valuers / Reserve Bank’s inspecting officers, is not more than 10 percent, ab-initio, of the outstanding exposure. ‘Exposure’ shall include all funded and non-funded exposures (including underwriting and similar commitments). ‘Security’ will mean tangible security properly charged to the bank and will not include intangible securities like guarantees, comfort letters, etc.