The RBI directive is critical as banks would not be able to sell the physical shares held as collateral from January 4. As of now, banks cannot sell their own shares in these scrips in physical form as they come under the category of institutions but from January 4, all investors will not be able to buy or sell physical shares. This would mean that the collateral which belongs to the investor would also have to be necessarily sold in the demat form and hence it is imperative for a bank to protect his collateral by dematerialising it well in advance.

In that sense, the RBI directive,which could have come earlier, is aimed at sending a clear signal to banks that it is about time that they realised that the market is moving to a demat environment and they gear up for this.

It is learnt that the National Securities Depository Ltd (NSDL) had urged the Reserve Bank to ask banks to begin dematerialising the collateral held by them, which by rough estimates could be upwards of Rs 4,000 crore.

There was a reason for this. In the event of a loan default, a bank would find itself not being able to sell the collateral and thus would have been in a spot. It could at this stage either be forced to call back the loan, an investor-unfriendly measure or ask the client to replace the shares with those which are not in the mandatory demat mode.

If a bank was saddled with physical shares, it would be forced to first dematerialise them by transferring them in its name at a cost and then seek to sell them. This could be time consuming and cumbersome.

"It is possible that some banks would have givenadvances to their clients against physical shares of companies which have been shortlisted for mandatory demat trading. In the event of such borrowers defaulting on the repayment, the banks will not be able to sell them and the collaterals may turn to be of nil value. Banks are, therefore, advised to take immediate steps to get them dematerialised well before the dates announced by SEBI in this regarding compulsory trading in demat form," the RBI circular states.

It adds: "Banks are also advised to watch for any SEBI announcements mandating trade in demat form in other scrips also, so that necessary actions are taken for safeguarding the security well in advance."