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Pledging of shares

  • February 7, 2023
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Pledging of shares

Subject : Economics

Concept :

  • A pledge of stock or share pledge means using shares as collateral and taking a loan against them.
  • Shares are basically the assets of the company or a shareholder.
  • Pledging is a way by which the promoters of any company take a loan against the held shares to meet these personal or business requirements including fulfillment of capital requirements, expansion of business, starting a new venture, and so on.

Why do promoters pledge shares?

  • One of the methods promoters use to raise finance is to take loans against their holding in their company from banks or non-banking financial companies.
  • For these financial institutions, these shares are collateral.
  • Promoters can raise funds for various reasons-for meeting requirements of the business or personal needs.

Can lenders sell the shares pledged by promoters?

  • Banks/lenders can sell the pledged share if the price of the stock falls closer to the value agreed in the contract between them and the company.
  • Typically, the amount that is lent by banks/NBFCs to promoters is less than the market value of the shares.
  • This shortfall is the margin is the amount that these lenders retain as security.
  • In case the stock price falls, lenders ask the promoter to provide more cash or shares to top up this margin.
  • If the promoters are not able to top up the collateral, the lenders can sell the shares to maintain this margin. Conversely, revoking of pledged shares by promoters is seen as a positive sign.

What is the risk for retail investors in this?

  • High promoter pledged shares can wreak havoc in stock if price continues to fall and lenders sell these shares in the market.
  • The sudden supply of shares can lead to further price fall and is a risk for retail investors who may have to sell the shares for a significant loss.
  • Shares of companies with high pledged promoter holding tend to witness higher volatility.
  • The risk is assessed on the basis of the amount of pledged shares as a percentage of the total shareholding.
  • A stock is considered a risky bet if pledged shares are more than 50% of the total shares in the company so ideally, retail investors should avoid such stocks.
economics Pledging of shares

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