loan against share
These days, secured borrowing is more than just simple collateral like property or gold. Collateral means the asset you pledge to take a loan. If you invest in stocks, you can also use them as collateral to get funds for emergencies, personal needs or business purposes. Loan against shares works in the same way as borrowing money by pledging your gold jewelery with the bank. The bank lends you money, you pay interest and when you return the money, you get your shares back. Let us understand all the important things related to this in detail.
As long as the loan remains active, you continue to receive dividends on your pledged shares. Also, if the company announces a bonus or a stock split, those extra shares also become yours. The pledged shares simply have a lien mark in your demat account so that they cannot be transferred without removing the lien, but the ownership still remains with you.
The Reserve Bank of India (RBI) requires a maximum loan-to-value (LTV) ratio of 50% of the current market value of your shares. This means that if the current value of your pledged shares is Rs 20 lakh, then you can get a maximum of Rs 10 lakh. Additionally, lenders can extend loans only against Group 1 shares on the National Stock Exchange (NSE), which are shares traded on at least 80% of the days in the last six months.
Keep these things in mind while taking a loan
In an ET report, VSRK Capital Director Swapnil Aggarwal says that while taking loan against shares, borrowers should never take more than 50% loan-to-value (LTV) ratio. They say this conservative approach helps protect against sudden market fluctuations, ensuring investors are less likely to face margin calls if share prices fall. Maintaining a low LTV also ensures that there are enough funds to cover potential losses, thereby reducing financial stress. RBI has recently proposed to increase the LTV ratio for loans against shares from the current 50% to 60%. There is also a proposal to increase the maximum amount of loan that can be given to people against shares by 5 times to Rs 1 crore.
when the market changes
Although a higher limit will enable loan takers to get more funds without selling their shares, they should still be careful while taking higher loans. Recall our earlier example of loan of Rs 10 lakh against shares worth Rs 20 lakh. If the value of your share falls by 20%, your eligible loan limit reduces and the LTV ratio increases to 63%, which the lender must maintain as per the existing mandate of 50%.
pledge or not
For this, experts recommend making two types of portfolios.
- Pledgeable Portfolio- This should include very liquid, stable stocks like blue chips and high-quality midcaps. Brokers usually offer higher margins on these and their price movement can be more predictable. Still, investors should ideally stick to 40% LTV and not the maximum allowed by the broker.
- Never pledge your portfolio- This should include small caps, SME stocks, newly listed companies, scripts with low liquidity and scripts with momentum. These stocks can move up and down rapidly, have crazy volumes and can very easily trigger margin calls. Such stocks should generally never be purchased with borrowed funds.
What happens when a stock sinks?
The overall thing is that if the stock sinks then the LTV ratio will increase. Suppose you pledged shares worth Rs 20 lakh and took a loan of Rs 10 lakh. LTV was 50%. Now if the share price falls from Rs 20 lakh to Rs 15 lakh then your LTV will increase to 66%. Whereas the bank is required to keep LTV at 50%. Therefore the bank will immediately send you a margin call. When the margin call comes, the bank will ask you to either repay some of the loan or add more shares/cash. You usually have only 23 days.