Whether it is CG power, Suzlon Energy, Essel Group, Anil Ambani-led Reliance Group or Apollo Hospitals, the rise in pledged shares by promoters of listed companies in the recent past has caused jitters on Dalal Street.

As an investor in the market, here is all you need to know about pledged shares.

What does pledging shares mean?

When one takes loans against the shares held, it is called pledging shares. This means that shares are offered as collateral or security against the loan taken by the individual that has pledged his/her shares. Shares can be pledged by a promoter or an investor.

Who gives loans against pledged shares?

Banks or nonbanking finance companies (NBFC) can lend money against shares.

Why do borrowers have to resort to pledging shares to get funds?

Borrowers can pledge shares to meet any shortfall in capital for business or personal requirement. Pledging of shares is more common in companies where promoter shareholding is high.

How much can be borrowed against pledged shares?

The minimum collateral value is agreed between the lender and borrower. An individual can typically borrow anywhere from 50 percent to 80 percent of the value of their shares. For example, if the total value of the shares pledged is Rs 100, a borrower can borrow anywhere between Rs 50 to Rs 80 against these shares. Typically, the borrower and lender have an agreement on the margin threshold which has to be maintained by the former at all times.

Does ownership gets transferred to the lending entity once shares are pledged?

Ownership is retained by the individual taking the loan at the time of pledging the shares. However, if the borrower is not able to meet the repayment obligations, the lender can sell pledged shares to recover money.

What happens in the event of default by a borrower?

If the value of shares falls below the minimum value agreed between the borrower and lender, the latter can sell off the pledged shares and recover money.

What are the implications of pledging shares?

Pledging of shares by promoters beyond a certain threshold raises the risk of some of this equity being sold in the market in case he/she is not able to repay the loan on time or provide additional collateral if the margin threshold is breached.

Since the loan is given against the value of the shares, as share prices fall, the total value of the collateral falls. This can trigger a margin call. This, in turn, can put pressure on the borrower who has pledged shares to take steps to arrest the price fall such as producing more collateral, selling other assets, etc.

What is a margin call?

When a margin call is triggered, the borrower must either deposit more cash or securities with the lender as additional collateral or sell the shares pledged to settle the loan. A forced sale of pledged shares could create a vicious cycle, resulting in the company’s share price falling even further.