Gitanjali Gems

99% of companies with significant promoter share pledging witnessed deterioration in financials: FiND Study

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Recent fraud at Punjab National Bank (PNB) worth Rs 145 billion has once again brought to the fore the inadequate risk management in the Indian banking system. There is no denying that banks need to strengthen their existing risk management systems to avoid such frauds and arrest alarming rate of growth in stress assets.

There is a plethora of actionable data available on the web which can not only help banks be vigilant on a particular borrower but also help decide whether to increase the credit limit to a certain borrower. One such data set is promoters’ pledged shares holding, which can be consumed in risk assessment of corporate borrowers.

In our view, substantial pledging of shares by the promoters is a potential red-flag as it is an indication of the stress that has piled up on corporate finances. Moreover, a significant drop in the company’s share price may result in the invocation of pledged shares. This may also lead to loss of management control for the promoters.

At the same time, red flags related to promoter pledged shares can act as a leading indicator to the deterioration in the company’s financial performance. To test this hypothesis, we back-tested our business rule output to find out companies with a significantly higher percentage of pledged shares for the December 2016 quarter. We applied the below-mentioned rule to identify such companies:

Promoter’s pledged shares % is more than 50% of total promoter shareholding

Our system identified 269 companies meeting the above rule for the December 2016 quarter. As a next step, we checked if there is any deterioration in the financial performance (captured by FiND Financial Risk score) for these 269 companies post-December 2016 quarter.

We found that: 99% of companies witnessed a deterioration in Financial Risk score in the subsequent quarters. Read the rest of this entry »