Thread by @tapak7

Forced selling by NBFC's who have loaned against shares (LAS) is exacerbating sell off in cash mkts. There is a case for RBI to reduce margin requirments for LAS to mitigate some of this stress with little impact to lenders @RBI @nsitharaman @FinMinIndia

I explain:

Currently RBI mandates that a minimum 50% LTV be maintained at any point for LAS. So if one borrowed 50 against share worth 100, then if share falls to 80, investor should bring in additional 10 as collateral. OTH, if share goes to 120, investor can borrow an additional 10!

With this rigid margining system, in a rapidly falling market, NBFCs r forced to sell collateralised shares if clients can't meet margin requirements within mandated time frames. While forced selling is theoretically possible, r markets clearly lack ability to absorb this selling

Way forward would be a flexible margin system that reduces margins: to say 35 or 40% in such times. A swift sharp reduction of the margin will provide more time to bring a sense of calm which is required in the system.

Y reducing margins now is not bad risk management: Falling asset prices give a sense of fear, but fact is that when an asset class as a whole falls dramatically in price, margin of safety in terms of intrinsic worth of the asset class actually goes Up, NOT Down. & vice versa.

On this basis: when mkts rise rapidly, the LTV should be increased to discourage aggresive LAS & when markets have corrected v dramatically, as now, the LTV can be lowered, as margin of safety (MoS) rises. A flexible approach. Clearly MoS now is much higher than 3 weeks ago!

4 lenders: there is still a 35%-40% margin at depressed prices! Worst case lender gains control of asset.but this will b temp situation. good super cheap assets easilly find buyers once fear & panic subside -mostly at a profit

The problem only comes in case of poor quality assets. For LAS of trading / investing clients this should not be an issue because anyways, most of the collateral is bigger & better cos. For LAS against promotor pledge a case by case look is essential.

Flexible margining is anyways done by @RBI for credit markets: When times r tight they reduce CRR (which is like a margin banks have kept with RBI). They also relax stressed assets recognition norms to give time, as it becomes evident that many assets r only temporarily stressed

The right signalling can have dramatic impact on an investors behaviour

As much as my thread sounds counter intuitive, lowering margin requirements after such a correction is one way to reduce the forced selling without any real increase in risk on the lenders balance sheet

Policy apparatus should b geared toward practicality & not idealism. Forced selling of shares is only going to hurt markets, lender and the system - including small investors in MFs. @RBI @nsitharaman @FinMinIndia Act fast.

Disclaimer: I have no loan against shares