India’s financial markets are feeling the shockwaves from a series of regulatory crackdowns targeting the country’s booming initial public offering (IPO) financing and gold lending sectors. In a bid to mitigate risks in the rapidly expanding financial system, regulators are imposing new restrictions that could significantly impact lending practices and the IPO market.
This week, shadow banks — non-banking financial companies (NBFCs) — became the latest target of the Reserve Bank of India (RBI), which imposed new limits on their lending activities. This follows recent actions by the RBI to restrict Paytm’s banking affiliate from accepting new deposits and the Securities and Exchange Board of India (SEBI)’s efforts to protect mutual fund investors from the rising risks in small-cap stocks.
The new regulatory measures could lead to even more stringent actions in the coming months, as the RBI continues its inspections of major non-banks involved in IPO and equity market financing. Sources familiar with the matter have indicated that the central bank has deployed a specialized team of professionals to conduct detailed and comprehensive inspections of these institutions.
“We expect more steps in other parts of the credit funnel,” said Pranav Bhavsar of India Independent Insight, who shared his outlook on Smartkarma. He emphasized that the ongoing crackdown on shadow bank stocks “is here to stay and possibly intensify.”
The RBI has not yet responded to requests for comment regarding the recent crackdowns.
A Booming Economy with Regulatory Caution
India’s economy is thriving, with growth rates exceeding 6%, and the demand for loans and IPOs surging. The country’s stock market has also experienced consistent gains over the past eight years. However, regulators are increasingly concerned that this growth could lead to excessive risk-taking within the financial sector.
Over the past several months, the RBI has urged financial services firms to strengthen their governance and risk management systems, even though bad debts are currently at a decade low. The central bank has clamped down on unsecured lending, increased provisioning requirements for banks, and warned financial institutions to be more vigilant in customer verification to prevent fraud and money laundering.
In January, SEBI Chairwoman Madhabi Puri Buch voiced her concerns about certain malpractices, including the use of “mule accounts” and inflated IPO application numbers. “We are unhappy about some of the malpractices that we see,” she said. “We now have the data and we will act.”
Impact on Shadow Banks and IPO Financing
India’s shadow lenders, which typically provide credit to clients outside of the traditional banking system, including small businesses with unpredictable cash flow, are now facing increasing scrutiny. This week, the RBI took action against two prominent shadow lenders: JM Financial Products Ltd. and IIFL Finance Ltd..
Shares of JM Financial dropped by 20% on Wednesday — the maximum daily limit allowed by the exchange — marking the steepest intraday decline in four years. Similarly, IIFL Finance shares also plummeted by 20% in two consecutive sessions, although both companies have since recovered some losses.
JM Financial has been prohibited from extending loans against shares and bonds after an inspection uncovered serious deficiencies in its financing of IPOs and bond offerings. IIFL Finance, meanwhile, has been ordered to cease gold lending after the RBI identified “material supervisory concerns” in its portfolio.
In a statement, JM Financial denied any regulatory violations and pledged to cooperate fully with the RBI. The company also downplayed the impact of the crackdown, noting that IPO financing contributed just 0.3% to its parent company’s profit for the nine-month period ending in December. IIFL Finance has also expressed its commitment to complying with the RBI’s findings.
Fallout for the IPO Market
The restrictions on shadow bank lending are expected to ripple through India’s booming IPO market. Bank of America Corp. recently described the current and upcoming IPO landscape as the busiest “in our lifetime.” However, shadow lenders like JM Financial and IIFL play a crucial role in fueling demand by providing loans to retail investors eager to participate in new listings.
These loans often lead to oversubscription of IPOs, prompting warnings from SEBI about inflated application numbers. JM Financial and IIFL have also been key underwriters for many IPOs, ranking ahead of global firms such as Morgan Stanley and Goldman Sachs Group Inc.
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The RBI’s actions are likely to dampen the IPO financing market, with experts predicting that the astronomical listing-day gains seen in recent years may slow down. Amit Kumar Gupta, founder of Fintrekk Capital, noted that while the restrictions will impact IPO funding, “such surveillance is required,” and the broader market should remain unaffected.
Gold Lending Hit
In addition to IPO financing, the RBI’s crackdown on gold lending could significantly hurt firms like IIFL, which rely heavily on this line of business. As of December, gold loans accounted for nearly one-third of IIFL’s portfolio, valued at 774 billion rupees ($9.3 billion). In India, gold jewelry is often used as collateral for loans, especially by borrowers with low credit scores seeking short-term liquidity.
Despite the regulatory challenges, some investors remain optimistic about the future of shadow lenders. Two days after the RBI’s action against IIFL, Fairfax Financial Holdings Ltd., the company’s largest shareholder, committed $200 million in liquidity support. Prem Watsa, the billionaire founder of Fairfax, expressed confidence in IIFL’s management team, saying, “We have full trust and confidence in the company’s strong management team.”
India’s financial sector is facing a turning point as regulators step up efforts to curb risk and prevent excessive exuberance, with shadow banks and IPO financing being the first to feel the heat.
