The facility has also been moving online.
Mirae Asset Financial Services (India) recently introduced digital pledging for CDSL demat accounts, allowing customers to apply for a Loan Against Shares (LAS) through its website or mobile app. The company had launched a similar digital facility in 2022 for investors holding securities in NSDL demat accounts.
But how does a loan against shares work, how much can you borrow and what happens if the value of your shares falls?
How does a loan against shares work?
Under a loan against shares, an investor pledges eligible shares with a lender instead of selling them. The lender provides a loan against a specified portion of the value of those securities.
The percentage that can be borrowed is known as the loan-to-value (LTV) ratio. It varies depending on the lender and the securities being pledged.
For example, if eligible shares worth ₹10 lakh carry an LTV of 40%, the loan available against them could be up to ₹4 lakh, subject to the lender’s terms.
Under Mirae Asset Financial Services’ facility, eligible shares are divided into four categories based on factors including market capitalisation and price volatility. The applicable LTV ratios are 45%, 40%, 35% and 30%.
The shares are not sold when they are pledged. However, they cannot be freely dealt with in the same manner as unpledged holdings while they remain collateral for the loan.
Why do investors use loans against shares?
A loan against shares can provide liquidity without requiring an investor to exit an existing investment.
Nilesh Shah, Managing Director, Kotak Mahindra Asset Management, said investors should compare the cost of borrowing with the tax and investment implications of selling their holdings.
Selling shares can result in capital gains tax, depending on the nature and holding period of the investment. It also ends the investor’s exposure to that particular holding.
However, borrowing comes with an interest cost. Therefore, the decision depends on the purpose and duration of the borrowing, the cost of the loan and the implications of selling the investment.
Navy Vijay Ramavat, Managing Director, Indira Securities, an Indian stock brokerage and financial services firm, said investors should compare the borrowing cost with the tax and potential opportunity costs associated with selling an investment.
How much can you borrow against shares?
The loan amount depends on the market value of the pledged securities and the applicable LTV.
Under the facility announced by Mirae Asset Financial Services, customers can borrow between ₹25,000 and ₹1 crore against approved shares.
The full market value of the shares cannot be borrowed. For instance, shares worth ₹10 lakh with a 30% LTV would provide an eligible loan of up to ₹3 lakh, while shares with a 45% LTV could provide up to ₹4.5 lakh, subject to the lender’s conditions.
The same value of shares can therefore result in different loan amounts depending on the securities and their applicable LTV.
What interest rate do you pay?
The interest rate varies between lenders and loan products.
Under the Mirae Asset Financial Services facility, the interest rate is 10.25% per annum. The company said interest is charged only on the amount actually utilised and not on the entire sanctioned limit.
Investors should not compare loans only on the headline interest rate.
Shah said borrowers should also check the LTV, how collateral is valued, whether the interest rate is fixed or floating, processing and annual charges, prepayment terms, and the conditions for releasing the pledge.
What happens if the share price falls?
This is one of the key risks of borrowing against shares.
Because the loan is backed by market-linked securities, a fall in their value can increase the effective LTV. If the collateral falls below the lender’s required margin, the borrower may have to repay part of the loan or pledge additional securities.
If the borrower does not meet the margin requirement within the stipulated period, the lender may sell the pledged securities, subject to the loan agreement.
A forced sale after a market decline can result in a loss. The borrower could also remain liable for any outstanding amount if the sale proceeds are not enough to clear the dues.
Ramavat advised investors to maintain a buffer below the maximum permissible LTV and cautioned against using highly volatile stocks as collateral.
Can you increase or reduce the loan?
The borrowing amount can change during the tenure, subject to the lender’s terms.
An investor may be able to increase the eligible loan by pledging additional securities. The outstanding loan can also be reduced by repaying part of it and releasing a portion of the pledged shares.
Mirae Asset Financial Services said its customers can prepay or foreclose the loan at any time without charges.
How does digital share pledging work?
The traditional pledge process can involve coordination between the borrower, lender, Depository Participant (DP) and depository.
For CDSL demat accounts under Mirae Asset Financial Services’ digital facility, the customer enters the 16-digit Beneficiary Owner Identification Number (BOID). The eligible shares are then fetched from the demat account.
The customer selects the securities and quantity to be pledged. The request is authenticated through an OTP and sent to the DP for approval.
Once the DP approves the request, the shares are pledged digitally and the customer can proceed to create the loan account.
Mirae Asset Financial Services said the pledge and loan-account creation can take place on the same day after DP approval. It also said CDSL has more than 18.5 crore demat accounts.
Also read: ₹10,000 monthly SIP in this mutual fund has grown to nearly ₹59 lakh in 16 years
