As the financial industry continues to grow and evolve, so do the various borrowing options available to consumers. One such option is a loan against shares.
A loan against shares is essentially taking a loan against the collateral of your shares. In simple terms, it is a way to leverage your investments to access a loan. The loan is granted based on the value of the shares being used as collateral. This type of loan is commonly referred to as a ‘margin loan’ or ‘securities backed loan’.
There are several reasons why individuals take out a loan against shares. One of the most common reasons is to access additional funds without selling off their shares. It is also a relatively quick and easy way to access funds as the loan eligibility criteria are based on the market value of the shares being used as collateral, which makes the application process faster than other types of loans.
Loan Against Shares Eligibility
To be eligible for a loan against shares, you need to have a demat account with a depository participant (DP) and a trading account with a recognized stock broker. The shares being used as collateral must be held in the demat account and cannot be held in physical form.
The loan against shares eligibility and the amount offered can vary from lender to lender, but it is generally determined by the market value of the shares pledged as collateral. The loan-to-value (LTV) ratio is used to determine the maximum amount of loan that can be granted based on the value of the shares being used as collateral. For example, if the LTV ratio is 60%, and you have shares worth Rs. 10 lakh, you can get a loan of up to Rs. 6 lakhs.
Loan Against Shares Key Features
Loan against shares is offered for a fixed term, ranging from 12 months to 36 months, depending on the lender. The interest rate is usually higher than regular loans as it is a secured loan, and the lender bears the risk of fluctuations in the market value of shares.
The advantages of loan against shares include faster processing time, no restriction on end-use, and no pre-payment penalty. The borrower also gets the benefit of retaining the ownership of shares, and the returns generated from them during the loan period. Additionally, the borrower can access funds without selling their shares at a loss in a falling market and can benefit from a rising market.
The disadvantages of loan against shares include the higher interest rate, the risk of loss and fluctuations in the market value of shares, and the possibility of the lender liquidating the shares in case of default.
Industry Standard Practices
Loan against shares is an industry-standard practice where the shares being used as collateral are transferred to a lender’s demat account, and a lien is marked against them. The borrower retains the ownership of shares but cannot sell or transfer them till the loan is repaid.
The lenders evaluate the shares being used as collateral based on the market value, liquidity, and volatility. Generally, blue-chip stocks with high liquidity and low volatility are preferred as collateral. The lenders also have a margin call system in place, which means they can demand additional collateral if the market value of pledged shares falls below a certain level.
The lenders also have to comply with the regulatory guidelines laid down by the Securities and Exchange Board of India (SEBI) for lending against shares. The guidelines include maintaining a minimum margin, periodic monitoring of exposures, and disclosure of information on loan against shares activities.
A loan against shares is a convenient way to access funds without selling your shares. However, it is essential to evaluate all the pros and cons of the loan before opting for it. The lenders also offer a range of services and terms for loan against shares, and it is wise to compare them and choose the one that best suits your needs and circumstances.
The loan eligibility criteria vary from one lender to another, and it is crucial to understand them before applying. Additionally, the borrower also needs to be aware of the market risks and fluctuations in the value of the pledged shares.
Overall, loan against shares is a valuable tool for those who need quick access to funds and have shareholdings as collateral. The key is to ensure that you have a sound financial strategy and are aware of the potential risks and rewards associated with this type of loan.