What is loan against shares and how to leverage it for financial growth and flexibility

The uncertainties in life can result in unanticipated job displacement or the abrupt onset of a medical crisis, where people have no other option than liquidating their investments. However, it is never a wise financial decision to liquidate long-term investments for a short-term financial crunch, especially at a time when there are instruments like loans against shares. The loan against shares is an innovative financial instrument offered by both banks and NBFCs that enables capital market investors to raise money against their shares without having to sell them. 

What is loan against securities?

The concept is similar to a loan against fixed deposits, which only banks offer limitedly. Just like pledging your fixed deposit or property as security to get a loan, you can pledge your shares to get a loan. According to Sarvjeet Singh Virk - Co-founder &MD, Finvasia - in India, the loans against securities registered a substantial rise of 8 per cent by March 2023. 

"There are 123.50 million Demat account holders in India, which means there’s an increasing percentage of people who can leverage their shares to secure short-term loans," Virk said.

How can investors grow financially using this instrument? 

Let’s take a look at the same with an example. 

Aarti is a small business owner who runs a well-known bakery brand in the city. With her growing customer base and demand, she identifies an opportunity to expand her business by opening up another outlet in a bustling neighbourhood. The problem is that she has invested much of her wealth in stocks, which is an impressive portfolio of shares. She is in a dilemma whether to liquidate her investments or wait for some more time to open another store. Aarti finds a midway when she explores the option of availing a loan against a significant portion of the value of her shares. It was a win-win situation for her as she did not have to give up on her dream to expand, kept her investments, and at the same time, managed to grow financially with the business expansion. 

With loans against shares, just like Aarti, investors gain dual benefits — instant liquidity from quick disbursal of loans and maintaining the ownership of the investments. 

Things to keep in mind

In a loan against shares, you have two options – overdraft and demand. In the overdraft facility, investors get to borrow within a limit set by the lender against the shares pledged. The interest depends on the amount borrowed and the tenure, but the limit is revised periodically against the current value of the shares. 

Which shares are eligible for taking a loan?

Loan against securities allows individuals to pledge their stocks as collateral for a loan, but not every stock is eligible to be collateral. As per the RBI guidelines, you can only pledge the assets that fall in the Group 1 category, which includes stocks that have been traded frequently (at least 80 per cent of the days) in the past six months and have a lower cost impact of the trades. The specific set of stocks has been identified as collateral to ensure they are reliable and safe because of their liquidity and diversification. It ensures market stability and lesser upheavals. 

"Additionally, if you need a loan of more than Rs 5 lakh, only the stocks from Group 1 can be used as collateral for a loan. One can get a loan up to Rs 20 lakh with Demat securities held electronically," Virk summed up.