The Reserve Bank of India (“RBI”) through its notification dated April 10, 2015 (“RBI Notification”) amended Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 whereby it mandated all Non-Banking Financial Institutions (“NBFC”) (having an asset size of 100 crores or above) to maintain an LTV (Loan to Value) ratio of 50% (fifty percent) at all times. In other words, NBFCs are prohibited from granting a loan worth more than 50% (fifty percent) of the value of the assets against which the loan is being granted. One class of security which is sometimes provided by the borrowers is a pledge of shares. Where any such pledge is taken as a security, the NBFCs are required to report to stock exchanges on a quarterly basis, the details of the shares pledged in their favour, by the borrowers for availing loans.

The RBI also released a clarification dated April 10, 2015 stating that these guidelines do not apply to unlisted shares.

The legal framework surrounding NBFCs offering loans against unlisted shares presents a nuanced picture. While the Banking Regulation Act, 1949 empowers banks to grant such loans subject to specific restrictions, there's an absence of explicit legislation governing this practice for the NBFCs.

This distinction underscores a critical gap in regulatory oversight concerning the NBFCs and the use of unlisted securities as collateral.  This situation leads to ambiguity regarding whether an NBFC has the authority to issue loans against unlisted shares. Therefore, in this article, we aim to explore the feasibility of obtaining a loan from an NBFC using shares of an unlisted company as collateral.

We did notice that there have been some instances where NBFCs have granted loans to borrowers against unlisted shares. One such instance is when PTC India Financial Services Limited (an NBFC registered with the RBI) granted a loan to NSL Nagapatnam Power and Infratech Limited upon pledging 31,80,678 shares of NSL Energy Ventures Private Limited. Similarly, IFCI Limited, another RBI-registered NBFC, has recurrently offered loans to borrowers against shares of unlisted companies. However, it is not very common for NBFCs to go down the pledge route, especially, in relation to the unlisted companies. There are certain risks involved. In the next section, we have highlighted some of the risks that the NBFCs face and how such risks could be mitigated by the NBFCs:

In conclusion, while there appears to be no legal barrier for NBFCs to offer loans against unlisted shares, it's a practice fraught with risks such as the illiquid nature of securities, restrictions of transfer, unstable valuations and the lack of transparency. Considering the risks associated with the transaction, the practice seems uncommon in the market. However, by conducting a thorough verification encompassing a title check of share ownership, credit appraisals, independent valuation of the pledged securities, and careful scrutiny of the material documents of the borrower, which is essential to mitigate potential defaults, could open up a viable option for private company and other entities holding shares of private companies in raising funds and could also open up an investment sector for the NBFCs.

Authors: Neeraj Vyas (Partner) & Abhishek Malhotra (Associate)