Loan Against Securities

If you are looking to raise short term funds quickly and have a sizeable investment portfolio, loan against securities is an option you can consider. In this post, let’s look at loans against securities in detail and assess whether you must consider such loans.

What Are Loans Against Securities?

As the name suggests, you can borrow against your financial investments such as shares, mutual funds, debentures, insurance policies, small savings schemes etc. Both banks and NBFCs offer Loan against Securities facility.

How Much Loan Can I Get?

Different banks and NBFCs will have their internal policies. Typically, loan amount will be lower for equity shares or equity MF units as compared to debt investments. Reason is that the value of equity investments can decline sharply. Banks or NBFCs provide a lower loan-to-value (LTV) for equity investments to guard their interest against such sharp declines. Banks need a greater cushion with equity investments. For instance, you may get only a loan of Rs 5 lacs against equity shares/MF units of Rs 10 lacs while you may get a loan of Rs 8 lacs against debt security of Rs 10 lacs. HDFC Bank, ICICI Bank and SBI cap the maximum loan amount at Rs 20 lacs.

Not All Securities Are Created Equal

Banks won’t treat all securities alike. When it comes to giving loans, Rs 1 lac worth of a penny stock is not the same as Rs 1 lac worth of a Nifty stock. HDFC Bank even differentiates between private sector and public sector banks. Find the list of eligible securities for HDFC Bank here and the loan available against them. ICICI Bank too has a list of approved scrips against which it provides loan.

What Is the Eligibility?

It appears the loans are available to customers with satisfactory past relationship. This is what I found on SBI website.

This facility is available to our existing individual customers enjoying a past satisfactory relationship with SBI and maintaining their DEMAT Account with SBI Cap Sec. It is offered as an Overdraft or Demand Loan. Loan can only be availed in single name. NRIs are currently not eligible for this loan.

Even though ICICI Bank and HDFC Bank websites don’t mention anything, it is quite possible that existing customers may have a better chance of getting a loan against securities. Unlike SBI, these banks didn’t limit their depository participant (DP) to a group entity.

How Is the Loan Offered? What Is the Tenor of the Loan?

Such loan can be offered as a demand loan or as an overdraft facility. HDFC Bank and ICICI Bank offer only overdraft facility. On the other hand, State Bank of India offers both demand loan and overdraft facility. The tenor of the demand loan will be decided upfront while overdraft facility will be available for one year and subject to renewal every year. In case of overdraft facility, you only have to pay interest only on the utilised amount. However, in case of overdraft facility, the bank may limit your drawing power based on prevailing price of security.

What Is the Rate of Interest on Such Loans?

Since the loan is secured, you can expect the interest rate to be lower than personal loans. Interest rate for ICICI Bank provided loan against securities, in Q1FY2017, has ranged between 9.2% to 12.25% p.a. For HDFC Bank, rates were higher for loans against equity investments. For Q1 FY 2017, average lending rate for loan against equity was 10.95% while 10.57% against debt investments.

Are There Any Restrictions on End Use?

The loan amount cannot be used for speculation or capital market activities. As I understand, subscription to rights issue is an exception.

What If the Price of the Securities Goes Down?

Even though financial institutions keep good margin of security, it is quite possible the market price of shares/MF units decline sharply. In such cases, banks may ask you to furnish additional security or prepay the loan (at least of portion of the loan). If you don’t do either, banks can liquidate your security and recover loan amount.

In case of overdraft facility, the bank may reduce the drawing power. This will automatically limit your ability to withdraw. In case you have already withdrawn more than the reduced Drawing power, you may have to repay excess amount instantly or pay penal interest. Loan agreements have such covenants built in.

What If the Price of the Security Goes Up?

Nothing will happen in case of a demand loan. I doubt bank will offer you additional loan. However, in case of overdraft, the bank may consider increasing your drawing power.

What Is Single Scrip Lending?

Under single scrip lending, you can avail loan by pledging shares of one company. As expected, banks will permit single scrip lending for only high quality and liquid scrips. The bank wouldn’t take this risk with lesser companies. This is quite justified too.

With other scrips, the banks may demand shares from other companies too. For instance, HDFC Bank requires minimum two scrips (shares of two companies). Additionally, the single scrip shall not exceed 65% of the drawing power (overdraft facility).

What About Dividends and Bonuses on Such Pledged Shares?

Any dividend or bonus will accrue to you (and not to the lender). You have merely pledged your shares. That does not mean you have forgone your right to receive dividends and bonus shares. As I understand, bonus shares will automatically be pledged.

Points to Note

You will get loan against only select securities. The list will be available on bank website. Hence, forget about taking loan against penny stocks you own.
The bank may offer different margin against different kind of securities. For instance, you may get up to 50% against Reliance shares and only 25% against a midcap company.
If you have demat account with the same bank (DP), you may be able to apply for the loan online too. However, you still have to go through formal documentation. You can check the demo from HDFC Bank.

How Is Security Created?

You have to pledge your securities to the bank/NBFC. As part of the documentation process, you will have to fill up a pledge request form and submit it to the depository (NSDL or CDSL). In case of mutual funds, you will have to send a letter to the AMC (mutual fund house) or RTA (CAMS/Karvy) requesting them to mark lien in favour of the lender.

Should You Opt for Such Loans?

I don’t think so. You may be much better off selling off those securities rather than taking loan against them. Interest rate for the loan is likely to be higher than the returns on debt mutual funds. There might be a scenario where your investment is illiquid for some time, say in closed ended funds, Fixed Maturity plans (FMPs) or equity linked savings schemes (ELSS). In such a case, your hand might be forced.

In a few cases, it is quite possible that your shares have gone down in value (loss aversion) and you don’t want to sell those shares at a loss. You might feel that the stock price will rebound any day. Hence, you may be inclined towards taking a loan against the shares rather than sell those shares. Don’t fool yourself. Stock price will not revive just because you want to. Even if you hold shares of the best company in this world, you don’t know when the price will reverse for good. That is the nature of equity markets. Sell those shares. When you have the money, buy those again. Keep things simple. Its quite possible that the price will run up from you sale price. Well, it is also possible that the price goes down from your sale price. You need to exercise discretion. Don’t be too optimistic about your stock pickings. Be rational.