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NATIONAL LAW UNIVERSITY JODHPUR

COURSE: CORPORATE FINANCE LAW AND POLICY


SEMESTER: 1
ST
LL.M.; STREAM: BANKING & FINANCE



PROJECT TITLE:
LOANS AND ADVANCES AGAINST SHARES AND DEBENTURES


SUBMITTED TO:
DR. RITUPARNA DAS


SUBMITTED BY-
DIVANSHU SONGARA
UJJWAL KUMAR
SUDHANSHU CHANDRA




TABLE OF CONTENTS
INTRODUCTION........................................................................................................ 3
CHAPTER 1 FRAMEWORK OF LOANS AGAINST SHARES AND
DEBENTURES LOANS AGAINST SHARES AND DEBENTURES ..................... 3
CHAPTER II LOANS AGAINST SHARES AND DEBENTURES AND ITS
REGULATION IN INDIAN CAPITAL MARKET ................................................ 10
CONCLUSION .......................................................................................................... 12
BIBLIOGRAPHY ............................................................................................................ 13
BOOKS & CIRCULARS ............................................................................................. 13












INTRODUCTION
Considering the relation between the market makers and the route of loans and
advances against shares and debentures we have to look into the intricacies of the role
of market makers in the capital market. Market Making is basically aimed to inculcate
liquidity in securities that are not really frequented on stock exchanges. Typically, it is
the market maker, who is responsible for enhancing the demand-supply situation in
securities which is inclusive of stocks, futures and options (F&O). Having an idea of
the existing screen based electronic trading system could be helpful to understand the
concept of market making better.
1
By this system, orders are successfully placed by
the buyers and sellers, which are matched by the computer system. However, this
system is extremely beneficial for the actively-traded stocks, whereas lesser traded
ones are not really affected by the system. Most of the times, investors are not really
interested in thinly traded stocks in spite of good fundamentals, with the fear that
those items might not get traded frequently. In such a situation, market makers creep
in. Market making is solely done to infuse liquidity to lesser traded shares. Market
maker is typically an institution or a broker, who gets an incentive to recommend the
securities to the investors and thereby creating a market for the lesser traded options.
2

CHAPTER 1 FRAMEWORK OF LOANS AGAINST SHARES AND
DEBENTURES LOANS AGAINST SHARES AND DEBENTURES
Banks provide loans against security of shares/debentures/bonds to individuals, share
and stockbrokers and market makers. Loans against shares and debentures can be
given to individuals. For meeting contingencies and needs of personal nature. For
subscribing to rights or new issue of shares/debentures against the security of existing
shares/debentures. Loans will not be sanctioned, to Trusts and Endowments against
the security of shares and debentures, for speculative purposes, inter corporate

1
S. N. Gupta, Banking law in Theory and Practice, 4
th
Edition, 2013, Vol. 3, Universal Publications.
2
M. L. TANNAN, Banking Law and Practice in India, 22
nd
Edition, 2008, Vol.
1, Wadhwa Publications, Nagpur
investments and acquiring controlling interest in companies and against the equity
shares of the banking company to its directors.
3

Banks will not extend 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

The amount of loan generally does not exceed Rs.20 lakh per borrower. As per RBI
guidelines loans against security of shares, convertible bonds, convertible debentures
and units of equity oriented mutual funds should not exceed the limit of Rs.10lakh if
the securities are held in physical form and Rs.20 lakh per individual if the securities
are held in demat form. For subscribing to IPOs, loans given to individuals will not
exceed Rs.10 lakh. Banks may extend finance to employees for purchasing shares of
their own companies under ESOP to the extent of 90% of the purchase price of the
shares or Rs. 20 lakh, whichever is lower.
5

Banks stipulate a minimum margin of 50% of the market value of equity
shares/debentures. These are minimum margin stipulations and banks can stipulate
higher margins. Banks avail the facility of Pledge of the dematerialized
shares/debentures in the depository system, whereby the securities pledged by the
borrower get blocked in favour of the lending bank. The loan limit depends on the
valuation of the security, applicable margin and ability to service and repay the loan.
Loan is normally given in the form of overdraft facility against the pledge of the
securities. Interest has to be paid for the amount and period for which the overdraft
facility is utilized. A declaration is obtained from the borrower indicating the details
of the loans / advances availed against shares and other securities, from any other
bank, in order to ensure compliance with the ceilings prescribed for the purpose.
6

While granting advances against shares held in joint names to joint holders or third
party beneficiaries, banks normally ensure that the objective of the regulation is not
defeated by granting advances to other joint holders or third party beneficiaries to

3
Master Circular RBI/2013-14/76 DBOD.No.Dir.BC.14/13.03.00/2013-14.
4
Supra Note 3
5
EILLIS FERRAN, Principles to Corporate Finance Law, Oxford University Press, Indian Edition,
2008. ISBN 10: 0-19958-061-8.
6
Master Circular- Loans and Advances- Statutory and other Restrictions, DBOD No.DIR.BC.
42/13.03.00/2000-01.
circumvent the limits placed on loans/advances against shares and other securities. A
declaration is obtained from the borrower indicating the details of the loans /
advances availed against shares and other securities, from any other bank, in order to
ensure compliance with the ceilings prescribed for the purpose.
7

As stated in RBI circular
8
, banks capital market exposures would include both their
direct exposures and indirect exposures. The aggregate exposure of a bank to the
capital markets in all forms (both fund based and non-fund based) should not exceed
40 per cent of its net worth, as on March 31 of the previous year. Within this overall
ceiling, the banks direct investment in shares, convertible bonds / debentures, units of
equity-oriented mutual funds and all exposures to Venture Capital Funds (VCFs)
[both registered and unregistered] should not exceed 20 per cent of its net worth.
Loans against units of mutual funds are granted only to those units that are listed in
the stock exchange or for those units for which repurchase facility is available. If
there is a lock in period in the scheme then the scheme should have completed the
minimum lock in period stipulated. The amount of advance is linked to the net asset
value/repurchase price or the market value whichever is less and not to the face value.
Banks ensure that the advance should not be granted for subscribing to or boosting up
the sales of another scheme of mutual funds or for the purchase of
shares/debentures/bonds. Compared to loans against shares, the extent of funding
against mutual funds is generally lower at 40-50% of the base NAV.
Banks normally follow certain guidelines while sanctioning advances against
shares/debentures:-
1. The advance should be purpose oriented, taking into account the credit
requirements of the investor
2. The normal procedures for the sanction, appraisal and post sanction follow up is
followed

7
DENZIL WATSON & ANTONY HEAD, Corporate Finance Principles and Practice, Second Edition
2002, Taxmann India. ISBN 81-7808-734-0
8
Revised Guidelines on Bank Financing of Equities and Investments in Shares referred to in circular
DBOD. BP. BC. 119 / 21.04.137 / 2000-2001 dated May 11, 2001
3. Advances against the primary security of shares/debentures/bonds are not
combined with any other advance.
9

4. Banks satisfy themselves about the marketability of the shares/debentures and the
net worth and working of the company whose shares/debentures/bonds are offered
as security.
Shares/debentures/bonds are valued at prevailing market prices when they are lodged
as security for advances.
1. Advances against partly paid shares are not granted.
2. The advantages to customers obtaining loans against shares/debentures is
3. It enables instant liquidity against shares without selling them
4. It takes care of all investment as well as personal needs.
5. It is ideal for short term funding.
10

Thus we can observe that the tool of loans and advances against shares and
debentures is of great help and source for capital for the market makers because when
it comes to finances for the market makers the most handy asset they can mortgage is
the shares, debentures and mutual funds owned by them in the market and bank may
also prefer to give loans against such assets as the securities which are kept with the
bank are the shares and debentures and hence the banks can recover the loan by
selling of these securities in the share market, thus less chances of such loans and
advances to turn into non performing assets (hereinafter NPAs).
11

The banks in India vary in their by rules when it comes to loans against shares and
debentures. Suppose we take an example of State Bank of India, fully paid and blue
chip shares can be pledged, the time period of advancing such loans is based on the
time taken in the calculation of creditworthiness of the borrower, the repayment of the
loan is classified by the bank on the basis of whether the loan forwarded is in the way
of overdraft or structured demand loan, in the overdraft the repayment is restricted to
the maximum tenor limit of the loan which in the case of State Bank of India is three
years.
12


9
Master Circular- Loans and Advances- Statutory and other Restrictions, DBOD No.DIR.BC.
42/13.03.00/2000-01
10
Supra note 2
11
Supra note 9
12
https://www.sbi.co.in/portal/web/customer-care/faq-loan-against-shares-debentures
Banks provide loans and advances to traders, industrialists and businessmen against
security of some assets or from the personal security of the borrower. It is prudent for
a bank or a financial institution to obtain security against the loan given to the
borrowers. Almost 90% of the loans and advances granted by the banks are secured
against different types of assets.
13
The security provided by the borrowers act as a
protection for the loan amount. Secured advances provides a sense of safety to the
lender as it help them regain the amount lent. In case, the borrower fails to repay the
loan amount, the lender has the right to dispose the security and realize the debt.
Loans provided by the bank against shares include all the stock exchange securities,
which is broadly classified into government securities, corporate securities and
debentures. Here is a brief explanation about the various stock exchange securities
against which loans can be processed.
Stock Exchange Securities Includes
Securities issued by the Central Government and State Government, bonds and
Debentures issued by semi-government, such as municipalities, port, trusts etc.
Shares and Debentures issued by the joint stock companies.
Government Securities The government securities includes the following:-
Stock A stock holder is given a certificate which indicates the amount of a loan held
by him. The name of the stock holder is entered in the books of the public debt office.
The certificates issued here cannot be endorsed. There is a special transfer form
printed on the reverse side of the certificate. The title of the stock is passed on to the
new holder after the completion of transfer form and registration of the new holder's
name with the public debt office. Banks and financial institutions grants loan against
suck certificates.
14

Promissory Notes A promissory note is a promise made by the President of India in
case of Central Government and by the Governor of the State to pay the specified sum
of money to the holder of the note or to the person to who it is endorsed. The name of
the person is mentioned on the reverse side of the note along with other details like
date, terms of issue etc. it is a negotiable instrument in the hands of the borrowers.

13
Supra note 7
14
M. L. TANNAN, Banking Law and Practice in India, 22nd Edition, 2008, Vol. 1, Wadhwa
Publications, Nagpur.
The title of the note can be passed on by endorsement and delivery. A loan can be
processed against such a document.
15

Bearer Bonds It is a certificate that clearly states that the bearer is entitled to a
certain sum of money on a specific date. The bearer of the bonds possesses the
ownership. The title is transferable by mere delivery of the document. Banks and
financial institutions provide loans against bearer bonds.
16

Corporate Securities It is the ownership securities which includes equity shares,
preference shares and creditor-ship securities such as debentures. A loan can be
granted by various banks and financial institutions against share certificates and
debenture certificates.
Debentures It is a document issued by a company as an evidence of debt. It is an
acknowledgement of the company's indebtedness to its holders. A debenture
certificate carries a predetermined rate of interest, which is payable at regular
intervals. The principal amount is payable only after the maturity of the certificate.
The amount of debenture is secured by a fixed or floating charge on the company's
assets.
17

Merits of Shares as a Security
Liquidity Shares can be easily realized if the borrower is unable to pay the debt. The
existence of ready market provides liquidity factor to the security. The government
securities can be easily marketed and shifted to the central bank to get financial
accommodation in case of any emergency.
Safety Shares and stocks enjoy stability of value. In times of recession the value of
security may undergo fluctuations. However government securities are less
susceptible to such fluctuations. Nowadays even corporate securities are less affected
by the changing business cycles.
18

Less Legal Formalities The investigation process is less complicated and simple.
The formalities are less which facilitates easy transfer of the securities and reduces
expenses.

15
Id.
16
Supra note 8
17
RBI/2012-13/79 DBOD.No.Dir.BC.4/13.03.00/2012-13
18
Id
Easier Valuation The market value of shares can be easily ascertained from the
quotations given at the stock exchanges, financial reports and newspapers.
Negotiable Securities Securities such as debentures, bearer bonds, promissory notes
and share warrants are fully negotiable.
19

Precautions
A banker who grants loans against shares should first consider the nature of the
business of the issuing company, its past records and future prospects. These factors
have an important bearing on the value of the security which are as following:-
(a) The banker should select safer type of securities such as preference shares. A
banker should never accept partly paid-up shares because of the risk
accompanying it.
(b) The banker should not accept securities which are not associated with any stock
exchanges.
(c) The bankers should not accept shares of a private limited company.
(d) The bankers should keep in mind the marketability and dividend paying capacity
of the issuing company while granting loans against shares.
(e) The bankers should create a zero charge over the securities. The financial
institutions and banks should grant loans only to reliable customers.
(f) They should make sure that the loaned amount is used for the purpose mentioned
in the application.
(g) They should also make sure that the loan amount is used for ethical reasons only.
(h) The banks and financial institutions must consider all the principles of sound
lending before finalizing the decision of granting loans to any applicant
20
.




19
Supra note 18
20
Available at http://www.vitt.in/loans/against-shares.html#sthash.TVEBVXUU.dpuf.

CHAPTER II LOANS AGAINST SHARES AND DEBENTURES AND ITS
REGULATION IN INDIAN CAPITAL MARKET

Loans against Shares and debentures is an important way to secure when it comes to
financing an Initial Public Offer (IPO). Broadly, banks can acquire shares, debentures
and units of mutual funds etc., for three different purposes :
(a) for making direct investment in shares / debentures etc. at banks own risk;
(b) for making loans and advances to individuals and sharebroking entities for the
purpose of making investment in capital markets on their own account. Here, the
investment risk is that of the individual or stock-broking entities. Loans / advances by
banks are normally fixed in value and carry the stipulated interest rate, and the risk to
banks could arise on account of inadequacy of margins or the inability of borrowers to
meet their repayment / interest obligations to banks because of volatility in share
prices or other related reasons, and
(c) shares/ debentures may be assigned to banks by individuals and corporates as
collateral and additional security for certain approved purposes which do not involve
stock broking or investment in capital market.
These guidelines cover investments in shares, convertible bonds and debentures and
units of equity-oriented mutual funds and advances against equity shares, bonds and
debentures, units of mutual funds, etc. for purposes (a) and (b) above. In respect of (c)
above, banks are free to accept additional shares, debentures, units of mutual funds
etc. as collateral for approved purposes as per the normal banking practice and
appraisal procedures.
Ceiling on overall exposure to capital market :
1) The ceiling of 5 per cent prescribed for investment in shares will henceforth apply
to total exposure including both fund based and non-fund based, to capital market
by a bank in all forms. The ceiling will illustratively cover :
i) Direct investment by a bank in equity shares, convertible bonds and
debentures and units of equity oriented mutual funds;
ii) Advances against shares to individuals for investment in equity shares
(including IPOs ), bonds and debentures, units of equity-oriented mutual
funds etc;
iii) Secured and unsecured advances to stockbrokers and guarantees issued on
behalf of stockbrokers and market makers;
2. The 5 per cent ceiling will be computed in relation to the banks total outstanding
advances (including Commercial Paper) as on March 31, of the previous year. Non-
fund based facilities and investment by banks in non-convertible debentures and other
similar instruments (excluding Commercial Paper), should not be included in
computing the total outstanding advances of the bank. Further, for computing the
ceiling on exposure to capital market, direct investment in shares by banks will be
calculated at cost price of the shares.
3. As mentioned in paragraph 1 (iii) above, it is clarified that the ceiling of 5 per cent
will not include collateral of equity shares / bonds and debentures offered to the bank
by corporares other than NBFCs, for availing of secured loans for working capital or
other productive purposes which do not involve stock broking or investment in capital
markets. Advances made by banks to individuals for personal purposes like education,
housing, consumption etc., will also be outside the 5 per cent ceiling.
Ceiling on direct investment in shares, etc
Within the above overall ceiling of 5 per cent for total exposure to capital market, the
total investment in shares, convertible bonds and debentures and units of equity-
oriented mutual funds by a bank should not exceed 20 per cent of its net worth.
21

While making investment in equity shares etc., whose prices are subject to volatility,
the banks should keep in view the following guidelines
22
:
The ceiling for investment in shares, etc., as stated in the above paragraph (i.e., 20 per
cent of net worth), is the maximum permissible ceiling and a banks Board of
Directors is free to adopt a lower ceiling for the bank, keeping in view its overall risk
profile and corporate strategy
23
.
Banks may make investment in shares directly taking into account the in-house
expertise available within the bank as per the investment policy approved by the

21
Available at www.iibf.org.in/documents/ADVANCESSTATUTORY.pdf
22
Master Circular- Loans and Advances Statutory and Other Restrictions RBI/2012-
13/79 DBOD.No.Dir.BC.4/13.03.00/2012-13
23
REVISED GUIDELINES ON BANK FINANCING OF EQUITIES AND INVESTMENTS IN SHARES REFERRED
TO IN CIRCULAR DBOD. BP. BC. 119 / 21.04.137 / 2000-2001 DATED MAY 11, 2001
Board of Directors subject to compliance with the risk management and internal
control systems indicated below. Banks may also make investment in units of UTI
and SEBI - approved other diversified mutual funds with good track records as per the
investment policy approved by the Board of Directors. Such investments should be in
specific schemes of UTI / Mutual Funds and not by way of placement of funds with
UTI / Mutual Funds for investment in the capital market on their behalf.
24

Underwriting commitments taken up by the banks in respect of primary issues
through book building route would also be within the above overall ceiling.
Investment in equity shares and convertible bonds and debentures of corporate entities
should as hitherto, be reckoned for the purpose of arriving at the prudential norm of
single-borrower and borrower-group exposure ceilings.
25

CONCLUSION
As we have seen in the entire project work that the business of loans and advances is
being closely guarded by the regulations of Reserve Bank of India. The entire
framework of the regulations and the guideline shouldnt be seen as a stymie for the
business of banks related to loans and advances, but they are they facilitator for the
aforementioned business. It is an entire gamut which forms the very fabric of this
business and the role played by the banks and the apex bank in order to operate the
deployment of funds in the market by the ways of loans and advances. The master
circulars issued by the central bank have played their role and it becomes more
important in order to maintain the equilibrium of checks and balances vis--vis loans
and advances business of the banks all over India. The stipulations put under the
Banking Regulations Act, 1949 are in order to regulate the role of the officers of the
banks itself so that no loophole should be left which can help them to utilize their
respective positions to practice any activity which leads to creating nonperforming
assets. The role of bank officers has been of great concern in the recent reports and
actions taken by the central bank against the CEOs of different banks which has been
found involved in the advancement of loans to a companies like Kingfisher Airlines
which were not performing well. We can expect that the Reserve Bank of India will



25
Supra note 23.
come up with provisions related to this in forthcoming master circulars on the loans
and advances by the banks in the subsequent passage of time. Apart from the forms of
loans and advances as discussed in the project against the shares and debentures we
can see other areas of this rapidly developing business such as the loans and advances
given against the American Security Receipts (ADRs), Global Depository Receipts
(GDR) and Indian Depository Receipts (IDRs) in the market. The coming era in the
field of loans and advances will be of the derivatives. The leverage ratio of the banks
which is an inseparable element of the business of loans and advances by the banks
which relates itself from the profitability of the financial institutes (here banks). The
commodity market is also playing great role in the loans and advances market, the
bills of exchange are an important instruments which are used by the loan seekers to
get advances against the BoEs, the bullion market is already playing greater role in for
of loans against gold, but on the practical level the banks as such shows hesitations in
when it comes to loans against gold, however it cannot be excluded as the an
important functions of the banks.
With this I will rest my project work on the discussion that the regulatory framework
in an important structure which makes the entire market within the country. The
aspects of project finance and other ancillary and other areas of finance market issues
were worth study, but the limitation of the project work has restricted me going into
these issues, I hope that the learning in the class will be an elaborative opportunity
giver in order to expand my understanding and knowledge.

BIBLIOGRAPHY
BOOKS & CIRCULARS
S. N. Gupta, Banking law in Theory and Practice, 4
th
Edition, 2013, Vol. 3,
Universal Publications
M. L. Tannan, Banking Law and Practice in India, 22
nd
Edition, 2008, Vol. 1,
Wadhwa Publications, Nagpur
RBI/2012-13/79 DBOD.No.Dir.BC.4/13.03.00/2012-13.
Revised Guidelines on Bank Financing of Equities and Investments in Shares
referred to in circular DBOD. BP. BC. 119 / 21.04.137 / 2000-2001 dated May
11, 2001.
Master Circular- Loans and Advances- Statutory and other Restrictions,
DBOD No.DIR.BC. 42/13.03.00/2000-01.
Master Circular RBI/2013-14/76 DBOD.No.Dir.BC.14/13.03.00/2013-14.
EILLIS FERRAN, Principles to Corporate Finance Law, Oxford University
Press, Indian Edition, 2008. ISBN 10: 0-19958-061-8.
Master Circular- Loans and Advances- Statutory and other Restrictions,
DBOD No.DIR.BC. 42/13.03.00/2000-01.
DENZIL WATSON & ANTONY HEAD, Corporate Finance Principles and
Practice, Second Edition 2002, Taxmann India. ISBN 81-7808-734-0
Master Circular- Loans and Advances Statutory and Other Restrictions
RBI/2012-13/79 DBOD.No.Dir.BC.4/13.03.00/2012-13
Gupta, R K. Banking Law and Practice. New Delhi: Jain Book Agency, 2008.
Proctor, Charles. The Law and Practice of International Banking. London:
Oxford University Press, 2010.
Tannan, M L. Banking Law and Practice in India. Nagpur: Lexis Nexis, 2010.