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Share pledging simply means ‘giving shares as a collateral security to get a loan’. So it is a ‘loan against shares’. The ownership of the shares remains with the pledgor (i.e. person pledging the shares). However in case of a loan repayment default, the lending bank or financial institution can sell the shares to recover the outstanding amount. Generally, promoters of a company pledge their shares to raise capital for the company.

How does share pledge work?

Let us understand share pledging with an example. Lets say Pearl is a promoter in ‘Joe Black Ltd’ and owns 40% of the shares. The company has total shares amounting to Rs 10 lakhs and each share is of Rs 1. So here, Pearl owns 4 lakh shares of ‘Joe Black Ltd’. The market price per share is Rs 300. So Pearl has a equity investment of Rs 12 crores (400,000 shares x 300). The company wants to raise funds amounting to Rs 3 crores to start a new factory. Pearl pledges her shares worth Rs 3 crores which amounts to 1 lakh shares. Tomorrow if the price decreases to Rs 200 per share, Pearl will have to pledge the incremental shares with the lender.

What is a haircut in share pledging?

Haircut is the difference between the actual value of shares and collateral value of shares. It is the discount applied to the market value of the shares. For example, lets say Viraj pledges shares whose market value is Rs 2 lakhs. The lending bank or financial institution uses a 20% haircut. In this case, the collateral value of the shares with be Rs 160,000 (200,000 x 80%). This means the lender will give a loan of Rs 160,000 only against the pledged shares.

What are the advantages of pledging shares?

• Getting a loan by pledging shares is very simple. The loan is secured by the shares and so it is processed in a less amount of time.
• There is no tax impact of pledging shares.
• The shareholder does not have to sell shares to borrow money. In a bull market, the shareholder can get a higher loan as the investment value of the pledged shares increases.

What are the disadvantages of share pledging?

• In case the borrower defaults on the loan, the lender can sell the shares in the market to recover the loan amount.
• If the promoter of a company pledges shares and then defaults on the loan, then it can create a negative impression of the company. It can also negatively impact the companies share price.

How to pledge shares?

• The investor/promoter has to submit a request to pledge shares using their trading account with their broker.
• After receiving a request, the broker forwards the request to National Securities Depository Limited (NSDL) or Central Depository Services Limited (CDSL).
• NSDL or CDSL authenticate the request via email or mobile to verify the PAN or BO ID.
• Once the request is approved, the collateral margin is available for trading to investors/promoters.
• Also, once the loan is repayed, the pledged shares are released by the lender and transferred back to the investors/promoters demat account.

Impact of promoter’s pledging shares on stock price and the stock in general

• When promoters pledge a high number of shares, it can be viewed as a sign of financial stress. This can lead to decrease in stock prices.
• A high number of pledged shares by promoters is considered a high risk as in case of loan repayment default, the lender could sell the stock resulting in an ownership change of the company.
• When a large portion of the shares of a company are pledged by promoters, selling them in the open market becomes difficult for individual investors impacting liquidity.

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