Did you know that India’s retail credit market is growing quickly? A developing nation such as India needs capital, and much of it comes from bank and non-development financial companies (NDFC) loans.
Banks had lent more than ₹50 trillion to people as of November 2023. According to Mint, the amount loaned for personal use was around 40% more than the ₹36 trillion supplied to businesses.
According to RBI data, credit card transactions also increased significantly, from Rs 1.61 trillion in November 2023 to Rs 1.66 trillion in January 2024. Due to this growing demand for capital, loans secured by shares (LAS) are becoming more and more common. Then, what is LAS?
We’ll learn everything there is to know about loans secured by shares in this tutorial, including how they operate, why they’re becoming more and more popular in India, how to apply, and what rules and regulations apply.
Loans Against Shares: What are They?
Investors can borrow money by utilizing their shares as collateral through a sort of loan known as a loan against shares (LAS).
Due to its ability to provide fast cash without requiring the sale of stock holdings or causing any disruption to the portfolio, this kind of loan has gained popularity recently. With LAS, investors can keep ownership of their shares while leveraging the value of their investment portfolio.
How Do Share-Based Loans Operate?
When investors choose to use LAS, they go to banks or NBFCs and offer a loan secured by their shares. In addition to shares, mutual funds, bonds, and insurance policies can also be used as collateral. These loans come with an overdraft facility. Within the specified loan limit—which is usually determined by the value of the pledged asset—you are free to withdraw any amount.
The standard range of interest rates on LAS is 10.5% to 13%, contingent upon the policies of the lender and the state of the market.
The Increasing Adoption of LAS in India
The expansion of LAS has been driven by India’s growing demand for retail loans, especially from high-net-worth individuals who trade stocks and derivatives. These people frequently have sizable investment portfolios that appeal to lenders as security.
With their holdings of shares continuously rising, Indian households are likewise investing in the stock market more than before. Because of this, loans secured by shares are a practical choice for these households in need of rapid cash.
Even as LAS’s share of all loans is still relatively tiny, their growing popularity has prompted the RBI to establish some guidelines.
Regulatory Monitoring and Issues
The RBI is essential in controlling leveraged asset sales (LAS) to preserve market stability and safeguard lenders’ and borrowers’ interests. According to new RBI regulations, the only shares that qualify as collateral for LAS are group 1 shares, which are distinguished by their impact cost and trading frequency. The purpose of this regulatory framework is to reduce market volatility and the risks related to long-term assets.
To safeguard the interests of the borrower, RBI also maintains a comprehensive set of standards for loans secured by shares.
Qualifications for Loans Secured by Shares
To be eligible for a loan secured by shares, borrowers must fulfill specific prerequisites, which vary depending on the lender. Among them are a few of these:
- The age range is between 18 and 65 years.
- The individual’s name must be used to hold the shares.
- Submission of necessary paperwork, including a demat holding statement, proof of identification, proof of residency, and proof of income.
- If shares are held in the names of businesses, non-resident Indians (NRIs), Hindu Undivided Families (HUFs), or children, they cannot be pledged.
- Furthermore, shares in businesses where the borrower holds director or promoter status are not eligible for the pledge.
Loans secured by shares offer several advantages.
- Quick Access to Funds: This feature enables investors to obtain funds without having to sell their shares.
- Ownership Retention: When using their shares as collateral, borrowers do not give up ownership of those shares.
- Flexibility: Money may be utilized for a range of things, such as investments or personal needs.
- Reduced Interest Rates: When compared to unsecured loans, interest rates for loans secured by shares are frequently cheaper.
- No Credit Check: Lenders could not demand a thorough credit check because the loan is collateralized.
Drawbacks of Loans Against Stock
- Market Risk: Borrowers may be subject to margin calls or be required to pledge more security if the value of the pledged shares drops considerably.
- Interest costs: The interest that borrowers must pay on the loan amount can add up over time and raise the total cost of borrowing.
- Restricted Loan-to-Value Ratio: The maximum amount that borrowers can borrow is usually limited by the percentage that lenders are willing to lend against the value of the pledged shares.
- Possible Loss of Shares: Lenders may liquidate the pledged shares to recoup the unpaid balance if borrowers default on the loan.
Conclusion
If utilized properly, loans secured by shares can provide investors with a useful source of liquidity. Individuals can use assets such as stocks, bonds, and mutual funds as collateral for loans under the Loan Against Assets (LAS) program.
Typically, a portion of the market value of the pledged securities is used to calculate the loan amount. LAS is growing in popularity because of its flexibility and cheaper interest rates than unsecured loans.
Indian citizenship, a Demat account, sufficient qualifying securities, solid credit history, and steady income are usually requirements for eligibility. Interest rates, processing costs, and prepayment fees are a few examples of fees. Before pledging, it is important to understand the benefits and dangers associated with the various securities that might be pledged.
Divadhvik can help you understand if a Loan Against Shares is the right option for you. Contact us today to discuss your financial needs.
