Consider how wonderful it would be if we could use our savings that we have invested in various instruments twice by still remaining invested in them. Using nearly double the amount of capital invested in the market feels like a dream. However, it is possible through the concept of pledging of shares.
Many small investors may have limited cash margins despite holding stocks, ETFs, and mutual funds, resulting in missed trading opportunities. To avoid this disability, the investors are allowed to pledge their shares with their respective broker and can raise a significant margin almost equal to their capital along with their holdings remaining intact. For example if you have a holding of Rs1 lakh in your demat account, by pledging those shares you can raise another amount close to a lakh for investment or trading purposes.This concept is often overlooked by most of the investors.
Further in this article let’s discuss pledging of shares in a more detailed manner.
What is Pledging of Shares?
From the Promoter point of view, Pledging of shares is a method for a company’s promoters to obtain loans to meet their business or personal needs by keeping their shares as collateral to lenders.
From the Retail Investor point of view, Share pledging allows investors to trade larger volumes of stock. When investors purchase shares, their savings are held in the form of shares in their trading or derivative accounts. They can’t use the locked fund for a new trade even after they have shares as assets. This is why investors pledge their stock in their trading accounts. They can avail this facility through their respective brokers.
Points to be noted before pledging the shares
- Selected Investments: Not every investments are eligible for pledging, it depend upon the respective brokers
- Haircut Margin: When you pledge your shares you won’t get the same amount of margin you have placed as collateral rather some amount of margin will be deducted let’s say 10%( depending upon the broker) . which is known as the haircut margin.
- Locked Holdings: The holdings which are kept as collateral at the time of pledging shares will remain locked in the Investor’s demat account. It cannot be sold until and unless it is unlocked.
- Prohibited the use of funds over the collateral margin.
Financial Instruments Which can be Pledged
- Stocks: An investor investing into the stock market can pledge its holding by contacting the broker with whom he/she has a demat account.
- ETFs: An exchange-traded fund (ETF) is a pool of investments like stocks or bonds. ETFs allow you to invest in a large number of securities at once and have lower fees than other types of funds.
- Sovereign Gold Bonds: Sovereign Gold Bonds (SGBs) are gold-denominated government securities. They serve as a substitute for physical gold.
- Active Mutual Funds: Active mutual funds are mutual funds in which the fund manager actively decides whether to buy, sell, or hold the investments. On the other hand Passive mutual funds are not allowed to pledge.
Advantages associated with Pledging of shares
There are certain advantages associated with pledging shares.
- Re-use of capital: The capital which is being invested in the shares could be reused for day trading or for investing. This is the major advantage and the reason why most investors pledge their shares.
- Utilization of Opportunities: Due to limited capital many investors miss plenty of investment opportunities but through pledging of shares investors can use and invest almost double the amount of their capital invested.
- No transfer of shares: This is another important merit associated with pledging of shares. As the shares which are pledged will remain locked in the investor’s demat account and will be shown as holding.
- Entitled Dividend: As shares are not transferred from the demat account, therefore an investor is entitled to get dividend on its pledged shares.
- No cost charged for unpledging shares: Brokers do not charge anything to unlock the shares by the process of unpledging them.
Risk associated with pledging of shares
Bearish risk: The collateral margin which is obtained by the investor is always at risk , as at the time of bearish trend or when the market is falling heavily an investor tends to lose their collateral value.
Greed of returns: It’s a general human tendency that when we get a chance to earn more than what we could afford a normal attitude of greed enters into our mind. We could never feel satisfied with what we have. Hence, where there is greed in the market chances of blowing up one’s capital goes up.
Extra charges on overuse of margin: An investor raised certain collateral margin by pledging his shares has certain restrictions such as certain amount of cash should be kept as safety margin with the broker, for example if one has 1 lakh rupees of collateral margin then he could only use 80,000 remaining 20,000 is kept as a safety margin with the brokers. If the limit is violated then the investors would be liable to pay heavy charges.
Charges associated with pledging of shares
As we have already stated that no amount will be charged for unpledging the shares. But there is a certain nominal amount of 30-40 rupees including GST will be charged on per pledging request by the broker. However, the amount charged totally depends on the broker.
After getting aware of the pros. And cons. of pledging of shares , it is very much clear that the facility is favorable to those investors or traders who have spent a certain amount of time in the market and are much disciplined to be called as a profitable investor or trader. The newbees are advised to stay away from this facility as it has certain underlying risks which could be dangerous for their capital. Therefore, pledging of shares is both constructive if it is used in a disciplined manner and destructive if it is not handled with care. So an investor should know where he/she stands before availing this facility.