Pledging of Shares

Pledging of shares is one of the common practices in share market which means that an individual is using their shares as collateral in order to raise funds or secure loans. Promoters as well as individuals pledge their shares to raise funds and meet their financial requirements. The blog will guide you about the complete practice of pledging shares with its pros and cons.

What is Pledging of Shares?

In simple terms, pledging is to take loans against the securities you own and in this case, these securities are the shares held in your account.

Still complicated? Let us simplify the meaning of pledging.

Suppose you are in need to raise funds in order to meet the working capital requirements, as an investment strategy or to meet the financial requirements. Here, pledging comes into the picture which determines that you can keep your existing shares as collateral security with the broker without changing their ownership and gain margin funds in return. Therefore, if you pledge your shares that means you are taking a loan against the shares in possession.

How does Pledging Works?

When you take a loan from a bank, you are supposed to mortgage an asset as a security. Similarly when you take margin amount from the broker (lender), you are required to mortgage or pledge the shares as a collateral security and similarly pay the required interest on the margin amount. When shares are pledged, ownership remains with the investor only until the investor fails to repay the loan which gives an authority to the lender to sell the pledged shares and recover the amount else, the investors repays the amount and releases the pledged shares.

What is Pledging of Promoters Shares?

Promoters represent an entity of the firm who held the majority stakes of the company in its initial stages. Promoters participate in regular affairs of the business and are responsible for its regular operations. So when an entity is in need of funds for regular operations or expansion of the business, it can be done through equity, issuing corporate bonds, etc. While raising funds from pledging promoters shares, their shares are kept as collateral security for the loan by lenders.

Reasons to Pledge Shares

Typically, shares are pledged by the investors or promoters to meet the financial obligations and secure financing but let us talk in depth why an individual or a company requires pledging their shares.

Corporate Financing

Funds are required to expand the business activities, mergers, acquisitions and other regular operations of corporate activities. To finance the business operations, a company or its promoters might pledge their shares to obtain necessary funds.

Debt

During times of financial difficulties, investors might pledge their shares as a part of a debt restructuring agreement where they can assure the lender of their commitment to repay the debt.

Margin Trading

In margin trading, traders pledge their shares to buy more shares which is not possible for them with available funds. If the value of pledged shares falls, a margin call is issued by the broker to deposit the funds or sell a portion of the pledged shares.

Strategic Investments

Investors make strategic investments by pledging their shares as a partnership agreement where shares are pledged by one party as a commitment or the security of performance obligations.

Benefits of Pledging of Shares

In terms of financial flexibility and capital, there are several advantages of pledging the shares, read below to gain an in depth understanding about the pros of pledging of shares:

Capital Access

Pledging of shares is very useful for individuals to have access to capital instead of selling their equity holdings. This allows investors to gain more profits by having extra funds from the lender as it helps in financing business operations, expansions as well as personal financial needs.

Retention of Ownership

Investors do not lose the ownership when they pledge their shares. They can get more funds by pledging them instead of selling the shares and enjoy the benefit from potential appreciation in the share value and dividends.

Reduced Interest Rates

Pledged shares are in the form of security to the lender; hence the interest rate is lower as compared to unsecured loans.

Enhanced Liquidity

Pledging of shares allows investors to convert non-liquid assets or shares into liquid assets or cash which is crucial to meet immediate financial needs or obligations.

Investment Leverage

Pledged shares are used by investors to obtain margin loans to leverage their investment portfolio and buy more shares. It possesses significant risks but can enhance the potential in the overall portfolio of an investor.

Risks of Pledging Shares

Pledging of shares is nowhere bad until it is executed intellectually with smart moves as well as considering the risk factors.

Market Volatility

Due to fluctuating market conditions, the value of pledged shares can even fluctuate and fall significantly which might require the borrower to provide additional collateral or repay a part of the loan. Inability to repay the loan can lead to the forced sale of shares.

Interest Costs

Borrowers are obliged to pay interest rates to avail the loans secured by pledged shares and the investors might have to bear financial losses if interest costs are higher than the returns on investments.

Complexity and Legal Risks

Pledging of shares involves a lot of complexity with the complications of legal agreements and documentation. Due to the complexity involved, misinterpretations happen which can lead to legal disputes as well as financial losses.

Final Thoughts

Pledging of shares is a great practice which allows investors to take loan from the lender by keeping shares as a collateral security. Investors can use brokers like Dhan and Sharekhan to pledge their shares successfully as they are quite efficient to use.

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