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.