The Reserve Bank of India’s (RBI’s) working group set up to review the extant regulations on core investment companies (CICs) has favoured restricting the number of layers of such entities within a group to two by 2021. “Any CIC within a group shall not make investment through more than a total of two layers of CICs, including itself,” said the panel in its report. If the recommendation is implemented, it will cut down the room for leverage by companies.
- The RBI’s recent Financial Stability Reports (FSR) had pointed to the central bank’s discomfort over the high level of pledged shares by India Inc, and the risks arising out of the systemic inter-connectedness of various financial players.
- Securities and Exchange Board of India (Sebi) guidelines on governance seek to avoid multiple structures. So, the RBI panel’s advice to limit CIC to two levels is another reform for better financing arrangement. However, its timing is an issue, as business houses are already under pressure. RBI panel for maximum of two-layered core investment companies by 2021
- The Companies Act of 2013 restricts the group structure to maximum of three layers (which includes the top layer), but non-banking financial companies (NBFCs) have been exempted from this so far. And this, in turn, has facilitated the “proliferation of multiple layers of CICs in a group (with cross-holdings)”.
- Under the current structure, with no restriction on the number of CICs which can exist in a group, there can be “multiple gearing” on the same capital; this can cause excessive leveraging.
- Considering that a CIC can borrow 2.5 times of its adjusted net worth (ANW), if there exists two CICs in a group, then a capital of ~100 can be leveraged about 11.25 times. This is much more than what is allowed for NBFCs.
- With the addition of more CICs, the scope of leverage at the group level could increase exponentially. Operating companies and NBFCs, if any, are eligible to raise funds directly from banks and the market, besides getting funds from group CICs.
What is the FSR?
- The FSR reflects the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC) on risks to financial stability.
- It gives a picture of the resilience of the financial system.
- The Report also discusses issues relating to the development and regulation of the financial sector.
- The report analyses the overall state of the various segments as well as highlights the risk-related issues that could cause potential challenges.