If you need quick funds but do not want to sell your shares, pledging them can be a useful option. A pledge in stock market means using your shares as collateral to take a loan. You continue to own the shares, but the lender holds the right to sell them if the loan is not repaid. This method allows both individual investors and company promoters to raise money without giving up their investments. Understanding what is pledge in the share market works can help you make better financial decisions when you need funds urgently.
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How does pledging of shares work?
Pledging shares is like taking a loan against your existing stock investments. You do not have to sell your holdings; instead, you just promise them as security.
Here is how it works, step by step:
- Loan agreement: You contact a lender (like a bank or NBFC) and agree on a loan amount against your shares.
- Pledging process: You authorise your depository participant (like NSDL or CDSL) to mark those shares as “pledged.”
- Lender gets rights: The lender gets the right to sell those shares if you don’t repay the loan.
- Loan disbursal: The loan is credited to your bank account.
- Repayment: Once you repay the loan and interest, your shares are unpledged and returned to normal status.
Important: The shares stay in your demat account. You continue to receive dividends and rights, unless the lender sells the shares due to non-payment.
Promoter pledge vs Non-promoter pledge
Both promoters and regular investors can pledge shares. But the reasons and implications differ.
| Feature | Promoter pledge | Non-promoter pledge |
|---|---|---|
| Who pledges? | Company promoters | Retail or institutional investors |
| Common purpose | Raise funds for business or expansion | Raise personal funds or for trading |
| Disclosure requirement | Mandatory public disclosure | No public disclosure needed |
| Market impact | High – can affect stock price | Low – rarely affects market sentiment |
| Risk to lenders | Higher due to volume | Lower (individual value is smaller) |
What is a haircut or margin call in pledge?
When you pledge your shares, the lender will not give you a loan for the full market value. This is where the concept of haircut comes in.
Haircut = The percentage of the share value the lender will not lend against.
Let us say your shares are worth Rs. 10 lakh, and the lender applies a 30% haircut. You will get a loan of Rs. 7 lakh.
A margin call happens if the value of your pledged shares drops sharply. The lender may then ask you to:
- Pledge more shares, or
- Partially repay the loan to maintain the required ratio
Example: You pledge shares worth Rs. 5 lakh and borrow Rs. 3.5 lakh. If share value drops to Rs. 4 lakh, the loan becomes risky for the lender. You may get a margin call.
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Loan-to-value (LTV) ratio and collateral value
The Loan-to-Value (LTV) ratio is the percentage of your asset’s value that the lender is willing to give as a loan.
Here is what you should know:
- Typical LTV: Ranges between 50%, depending on the type and risk of the shares
- Collateral value: Determined based on current market price, liquidity, and past performance of the stock
- Updated daily: Most lenders re-calculate your pledged share value daily due to price changes
Purpose and uses of share pledging
Pledging shares is not just for emergencies. It can serve several needs:
- Raise working capital for business
- Fund a personal expense (wedding, travel, etc.)
- Use for short-term trading or margin funding
- Pay off a high-interest loan by taking a lower-interest secured one
- Avoid selling long-term investments
Risks and disadvantages of pledging shares
While pledging gives you liquidity, it comes with its own set of risks:
- Share value fall = margin call
You may have to bring in more collateral or repay quickly. - Forced sale by lender
If you can’t meet the margin call, the lender may sell your shares. - Loss of voting rights (for promoters)
In some cases, pledged shares don’t count towards voting rights. - High dependency on market conditions
Real-world example: A well-known company promoter pledged over 70% of their holdings to fund expansion. When the stock price crashed, lenders sold a big chunk of pledged shares, causing the stock to tank further. It shook investor confidence and affected the company’s image.
