Pledging of shares in the stock market can be a common practice. Pledging is where company shares are pledged as collateral security for obtaining loans from banks and financial institutions. It is common for individuals and companies to raise capital to meet their capital requirements, pay their existing debt, etc.
In this blog, we will discuss how pledging of shares works. Additionally, things to consider before pledging shares of a listed company.
Pledged shares meaning is the practice of using any shares as collateral to secure a loan. In this process, a shareholder or the pledged holdings (the pledgor) provides their shares to a lender (the pledgee) as security for a loan or credit, also called collateral margin. The ownership of the shares remains with the pledgor, allowing them to continue receiving dividends and exercising voting rights. However, if the pledgor fails to meet the loan obligations, the pledgee may have the right to sell the pledged shares to recover the outstanding amount. The pledge of shares as collateral security or margin against shares is used by investors and promoters to access capital while retaining ownership of their shares.
Pledging stocks involves the transfer of ownership of shares from the shareholder to the lender, as collateral security for a loan. The bank or financial institution holds the shares until you fully repay the loan. During this period, it works continues to enjoy the benefits of ownership, such as dividends and voting rights. However, if the borrower defaults on the loan, the lender has the right to sell the shares in the open market to recover the outstanding amount.
Let’s assume that the promoters of XYZ Ltd hold a 60% stake in the company. Suppose Rs.1 Crore shares are outstanding. Here, a 60% stake means promoters hold 60 lakh shares. So if the market price of each share is Rs. 500, then the promoter’s shareholding worth is Rs.300 crore (60,00,000 * 500). Now let’s also assume that the promoters want to raise Rs. 100 crore to expand the company’s manufacturing capacity and are seeking a loan from the bank.
As per RBI regulations, a loan-to-value (LTV) ratio of 50% is always maintained when lending based on the stock pledge. Since the proposed loan amount is Rs.100 crore, the promoters will have to pledge stocks of at least Rs.200 crore worth of shares with the bank; this translates to 40 lakh shares. One must rectify any LTV shortfall due to share price changes within seven working days.
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The practice of pledging shares can offer several benefits, including the following:
The pledging of shares can have several impacts on stock valuation:
To pledge shares of a listed company, the shareholder needs to follow these steps:
Non-promoter pledge involves individuals or entities outside a company’s promoter group using their shares as collateral for securing loans or financing. The Non-promoters may pledge shares to raise funds, fund other investments, or address personal financial obligations. However, it comes with risks, including the impact of stock price fluctuations on pledged shares, potential loss of voting rights, and the possibility of margin calls. Non-promoter pledges can affect a company’s ownership structure and financial stability, underscoring the importance of careful monitoring and management of such arrangements.
Stock pledging provides benefits as well as drawbacks. On the upside, it grants access to capital for different purposes, helping manage liquidity without needing to sell assets and enabling strategic investments. Some promoters utilise the company’s shares to finance other ventures while also benefiting from the dividends provided by the company.
However, some potential risks are higher risk of margin calls, negative market sentiment causing stock price fluctuations, and the chance of losing company control if repayment becomes difficult.
Whether share pledging is good or bad depends on its purpose, management’s ability to manage it effectively, and its consistency with long-term financial objectives.
Each promoter pledging shares of a company discloses this in their financial statements. Determining if a pledge of shares of listed company involves examining its quarterly financial reports, which provide information on the percentage of promoter holding and the proportion of pledged shares.
The percentage discount applied to the market value of the pledged shares is known as the haircut. The haircut percentage is a risk management measure that lenders use to protect themselves from a fall in the value of the shares. For example, if the market value of the pledged shares is Rs.1,00,000 and the haircut is 20%, the effective value of the shares will be Rs.80,000. This means the lender will give a loan of Rs. 80,000 against the pledged shares.
Unpledged shares, meaning the release of pledged shares by the lender after the borrower repays the loan in full. Once the shareholder repays the loan, the system transfers the shares back to their demat account.
Pledging shares can offer certain advantages, including:
While these advantages can be appealing, it’s crucial for shareholders to carefully consider the associated risks and terms of the pledging arrangement before proceeding, as fluctuations in share prices or failure to meet loan obligations can pose challenges.
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While pledging shares as collateral security can offer several benefits, it also involves certain risks that shareholders should be aware of:
To conclude, shareholders seeking short-term funding may find pledging shares a viable solution, providing easy access to funds without selling the shares outright. Nonetheless, this option carries risks, including potential loss of ownership and the possibility of forced sale. Therefore, it’s essential for shareholders to thoroughly assess the advantages and risks of pledging shares in the stock market and fully understand the terms and conditions of the pledge agreement.
As with any financial decision, weigh the pros and cons carefully and consult your financial advisor before investing.
Pledge meaning in share market, is the use shares as collateral to obtain loans. It allows individuals and companies to raise capital without selling their shares.
2. Can I sell the pledged shares?Yes, you can sell pledged shares. However, depending on your broker’s policies, you may need to unpledge the shares first.
3. What is the maximum number of different holdings I can pledge?The maximum number of holdings you can pledge varies depending on your broker. However, most brokers will allow you to pledge up to 100 holdings.
4. When will I receive the margin after pledging my holdings?The margin becomes available on T+1 day for the pledged stocks before 5 pm.
5. Is pledging of shares good?Pledging shares can be a good way to raise capital without diluting equity. However, it is important to manage the risk of the lender selling shares if the share price falls.
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