Investors in the modern fast-money economy are always in search of ways to handle liquidity without hurting their investment portfolio. The only solution that truly works and is gaining acceptance among Indian investors is borrowing on shares. Instead of selling stocks to raise money, lenders can use listed stocks as a guarantee and get access to liquidity quickly. The scheme also ensures investment security and financial leverage. Also, loan against shares’ interest rate is usually competitive, so this financial tool is easy and appealing.
What is a loan against shares?
Loan against shares is a share-based loan facility provided by banks or financial institutions where investors pledge their equity shares as collateral. The value of the security shares is ascertained by the lender, and the lender advances a fraction of this value as a loan amount, typically referred to as the Loan-to-Value (LTV) ratio. The facility allows investors to get access to funds without liquidating their shareholding.
Loans against shares are easily available in India from banks, NBFCs, and broking firms. Pledged shares are easily marketable and are quoted on formal stock exchanges like NSE or BSE. Title rights and dividend receipts on pledged shares are not negatively impacted by the investor for running the loan in comparison with the sale of shares.
Why borrow against shares instead of selling stocks
Avoid liquidation losses and maintain long-term appreciation
Sharing sale is, in a sense, giving up future potential gains, especially in a situation of a market recovery. By availing a loan against shares, one retains possession and appreciation of capital, as well as dividend. It suits long-term investors who perceive that their portfolio is going to grow in the future but need short-term cash.
Ability to be able to access funds at a quicker rate without impacting the market
Sale of massive quantities of shares would be sluggish and negatively impact market prices due to supply pressures. Share-backed loan provides instant access to the funds, typically within days. This implies cash needs instantly are met without jeopardizing the stock market and investor reputation.
Lower interest rates compared to other loans
Borrowing against shares is usually at a lower rate than unsecured personal loans or credit cards since the loan is secured. The interest rate on loan against shares is tailored with respect to the quality and value of pledged shares in order to promote risk-free borrowing. A good borrower can minimize finance cost to a significant extent by taking advantage of cost-saving rates.
Follow portfolio diversification
Sale of single stocks can disrupt an optimally diversified portfolio. Loan against shares allows the investor to maintain his asset allocation unchanged without disrupting his investment plan. It is especially useful during turbulent markets when diversification can keep risks in check.
Calculation of the rate of interest on loan against shares
Loan against shares interest rate is varying on various grounds such as borrower’s history, policy of the lending company, nature of the securities to be locked, and duration of the loan. The interest rate is 9% to 15% per annum in India, which is comparatively a low method of borrowing an advance.
Determine factors are:
- Quality and level liquidity: Blue-chip or large-cap stock receives lower interest rates since it is superior quality and of higher liquidity.
- Loan-to-Value (LTV) ratio: The LTV ratio is inversely related to the cost of interest. The greater the LTV ratio, the greater is the interest cost. SEBI regulations fix LTV at 50% in the case of stock of listed companies listed on recognized stock exchanges.
- Borrower’s profile: Favorable relationship with lender and credit history lead to lesser prices.
- Loan tenure: Lesser tenor will repay less interest than borrowing for longer periods.
The aforementioned banks, i.e., HDFC Bank, ICICI Bank, and Axis Bank, offer tailor-made loans against shares at reasonable interest rates. Investors avail the best lending option for their needs based on offers.
Procedure to avail a loan against shares in India
Investors avail a loan against shares by following the following procedure:
- Identification and pledge of shares: Investor selects such listed eligible shares from his Demat account as he desires to pledge.
- Loan application: Furnishing identity and income papers and details of pledged shares.
- Valuation of shares: Lender value the market value and the associated LTV ratio.
- Sanction and disbursement of loan: After the loan amount is sanctioned and credit check is performed, the loan amount is credited to the account of the borrower.
- Repayment and release: The interest and principal are paid by the borrower according to the repayment schedule. On repayment, the shares pledged are released back.
It is easy and causes no disturbance to the investor’s portfolio. Most of the lenders are only nominal processing fees and take no collateral but the shares being pledged.
Situation in which borrowing against shares is beneficial
Emergency funds without the need to sell investments
Unexpected money crises such as medical expenses or unexpected home repairs require cash at hand. Instead of selling shares when their value is lower or during unfavorable market movement, borrowing against shares is a hassle-free option.
Business growth or working capital
Entrepreneurs and equity investors businessmen can utilize their shareholding to obtain business growth capital without disposing of investments. They can easily reconcile business needs and personal investments.
Tax optimisation strategies
Issue of shares attracts capital gains tax. Loan against shares, however, entails no incidence of tax because ownership does not change hands. It saves the investors from money management as well as tax.
Don’t miss out on bull markets
Market conditions continue to fluctuate; selling shares during a bearish phase can lead to realisation of losses. Loan against shares ensures that investors are held in check and make profit when the market is good.
Risks involved in loan against shares
Though there are many advantages, loan against shares involves risks involved, and hence, these need to be determined by the investors:
- Market volatility: The unexpected decline in share price decreases the collateral value. The lender may insist on a margin of extra collateral or partial repayment.
- Interest burden: Even with low interest rates, interest payments get accumulated against total costs and must be reimbursed immediately.
- Loan default consequences: Default results in forced disposal of the pledged shares, and the same is disposed at a loss.
- Eligibility limitation: Not all the shares can be eligible, and the quantum of loan sanctioned depends upon lender’s policy and SEBI rules.
Prudence and caution toward such risk allow the borrowers to utilize the loans in the best possible way.
Compare loan against shares with other loan options
| Features | Loan Against Shares | Personal Loan | Loan Against Property |
| Security | Mutual fund or listed shares pledged to the lender. | None (unsecured). | Residential, commercial, or industrial property that has been mortgaged. |
| Interest Rates | 9%–15% annum, depends on quality of shares and lender. | 12%–24% annum, depends on credit rating and income profile. | 8%–12% annum, the lowest usually since it is secured. |
| Tenure | Short to medium term (up to 3 years). | Short to medium term (1–5 years). | Long term (5–15 years, sometimes 20 years). |
| Approval & Disbursal Time | Fast (1–3 working days; faster with demat/online pledge). | Moderate (3–7 working days). | Slow (7–15 working days because of property valuation, legal checks, and documents). |
| Loan Amount Eligibility | Dependent on Loan-to-Value (LTV) ratio, typically 50%–70% of share value. | Dependent on borrower income and credit history (up to ₹40 lakh or more). | Higher; 50%–70% of market value of the property, typically ₹1 crore+. |
| Impact on Investment/Asset | Shares are still in your name and still generating returns but are blocked for loan period. | N/A | Property is still in your hands but under mortgage; cannot sell without permission of lender. |
| Repayment Flexibility | Repayment flexibility; can prepay or part-prepay; interest only charged on usage (OD facility available). | Fixed EMIs; prepayment would attract penalty. | EMI-based repayment; prepayment possible, usually subject to charges. |
| Tax Implications | No capital gains tax as shares are not being sold. | No tax benefit. | No direct tax benefit; however, business/property development loans can be eligible. |
| Risk Factors | On declining share prices, top-up margin would be paid; risk of forced sale. | Hassle of heavy interest burden; default would affect credit rating. | Property facing risk of sale upon default; expensive legal process. |
| Suitability | Most appropriate for investors who need short-term liquidity without affecting portfolio appreciation. | Most appropriate for salaried/self-employed who need ready money for domestic purposes. | Most suitable for substantial funding needs (expansion of business, further studies, medical requirements). |
Conclusion
Borrowing against shares is a prudent and smart financial decision for Indian investors who need liquidity without losing the potential future appreciation. The credit facility allows for ease of acquiring funds, incurs lower interest than unsecured loans, and portfolio diversification is not compromised. Knowledge about the rate of interest on loan against share and other factors provides leverage to borrowers in using their securities effectively.
Share loans, unlike share sales, do not affect ownership, delay the timing of tax, and have several financial benefits. The investors must be cautious and consider their investment horizon and risk profile before availing themselves of this facility. They use this facility and make the best out of their financial position in India’s evolving capital markets.
Discussion about this post