Pledging of shares
- February 7, 2023
- Posted by: OptimizeIAS Team
- Category: DPN Topics
Pledging of shares
Subject : Economics
- 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.