Investors can meet cash needs without selling their securities.
The Reserve Bank of India has raised the per-individual limit on loans against shares (LAS) from Rs 20 lakh to Rs 1 crore.
The higher ceiling will allow investors to unlock more capital from their portfolios without selling their holdings.
Both banks and non-banking financial companies (NBFCs) offer LAS.
"As the restriction for banks for doing LAS was Rs 20 lakh, most high-net-worth individual (HNI) LAS customers went to NBFCs for this loan until now," says C R Chandrasekar, CEO, DhanLAP.
How it works
A borrower's securities are pledged as collateral. While shares remain pledged, they cannot be sold, though dividends and other corporate benefits continue to accrue. Once the loan is repaid, the shares are unpledged.
Interest rate depends on the borrower's profile and the lender.
"Rates usually range between 9 and 12 per cent per annum," says Harsh Vira, chief financial planner and founder, FinPro Wealth.
"For HNI clients or bundled offerings, rates go below 10 per cent," says Jugal Mantri, executive director and CEO, Anand Rathi Global Finance.
"The Reserve Bank of India's margin requirement is 25 per cent for demat shares and 50 per cent for physical shares," says Trivesh D, chief operating officer, Tradejini.
Only approved securities are eligible for this loan.
"Eligibility depends on factors like market capitalisation, stock volatility, and liquidity. Each bank has its own list of approved securities," says Adhil Shetty, CEO, BankBazaar.com.
Since collateral is pledged, lenders may approve loans even to borrowers with weak credit scores.
"Borrowers with poor repayment history may face higher interest rates, be offered a lower loan-to-value (LTV) ratio, or both," says Shetty.
Lower-cost loan
Customers typically use these loans for short to mid-term needs.
"The Rs 1 crore limit will allow borrowers to meet larger requirements such as working capital, business expansion, and short-term investment opportunities," says Anand K Rathi, co-founder, Mira Money.
Investors can meet cash needs without selling their securities. They can earn market returns, which, over the long run, are usually higher than the interest charged on these loans.
They can also avoid paying capital gains tax that arises on the sale of securities.
"The interest rate is lower compared to the 18-36 per cent charged for personal loans or credit cards," says Mantri.
Processing is faster as lengthy credit assessments can be skipped due to the availability of collateral.
"LAS can be taken as an overdraft or a demand loan," says Shetty. The overdraft facility allows flexible repayment, with no penalty for part or full prepayment.
Market volatility poses risks
The main risk arises from market volatility. A 10-15 per cent fall in the value of pledged shares can trigger a margin call.
"Borrowers must add more collateral, repay part of the loan, or offer other approved securities," says Rathi. Vira warns that borrowers risk losing pledged holdings in a prolonged downturn.
"Forced selling in illiquid stocks often triggers a downward spiral that worsens losses and puts extra pressure on the market," says Trivesh.
The sharp rise in borrowing limit could lead to over-leveraging. "Some borrowers may over-borrow during market upswings, assuming prices will always rise," he adds.
Precautions to exercise
Investors should avoid utilising the full loan limit.
"They should keep a buffer of 20 to 30 per cent below the maximum eligibility to avoid frequent margin calls," says Abhishek Kumar, Sebi-registered investment adviser and founder, SahajMoney.com.
He also advises maintaining emergency funds to handle margin calls within stipulated timelines.
Investors must also understand margin call procedures and forced liquidation scenarios before going for this loan.
Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
Feature Presentation: Aslam Hunani/Rediff
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