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Nath Balakrishnan

YOU are urgently in need of funds to tide over a contingency, but your money is locked in select equities. With depressed stock market conditions, you are not too keen to dispose them off, as you think they hold considerable upside potential. What do you do in such a situation? Resort to panic sales of shares? Seek financial assistance from friends and relatives? Would it not be better if there existed the option of you pledging your shares with a bank, and getting a loan based on the value of the equities?

This is precisely the service that most banks are offering nowadays. In this article, we will examine the scheme of providing loans against shares offered by three private sector banks: HDFC Bank, ICICI Bank and IDBI Bank.

Basic features

All banks that offer this facility have an approved list of dematerialised securities that can be pledged with them to get a loan. Banks can offer up to 60 per cent of the market value of he securities as loan. The amount sanctioned ranges from a minimum of Rs 50,000 up to Rs 20 lakh. A minimum of two scrips need to be pledged.

In the case of single scrip lending, HDFC Bank has set a limit of 50 per cent of the market value with a cap of Rs 10 lakh, and ICICI Bank lends up to Rs 20 lakh. IDBI Bank does not lend against a single scrip.

Once the loan is sanctioned, a current account — with added features such as a free ATM card and access to phone banking — is opened in the name of the person taking the loan facility. However, in the case of IDBI Bank, an overdraft account is opened in the customer's name, and he/she is entitled to a cheque book but not an ATM card.

Though a pledge is executed with the bank, benefits such as dividends and bonuses declared by the company whose shares are placed with the bank continue to accrue to the original shareholder. The tenure of the loan is one year, subsequent to which it can be renewed (or terminated), depending on the customer's preference.

Pricing of the loan

Interest charges on the loan are calculated on a daily basis, and debited to the customer's account at the end of every month. More important, the interest is imposed on only that part of the amount that has been utilised by the customer, and not on the entire sum sanctioned. In the case of HDFC Bank and ICICI Bank, interest rates share an inverse relationship with the amount sanctioned, and varies from 12.5 to 15.5 per cent in the case of the former, and between 12 per cent and 14 per cent for the latter. IDBI Bank levies an interest rate of 13.75 per cent, regardless of the loan amount sanctioned.

In addition to the interest charges, a processing fee is also collected. IDBI Bank charges 0.75 per cent of the amount sanctioned as processing fee, while in the case of HDFC Bank, the figure could be 0.25-0.50 per cent. No processing charges are applicable in ICICI Bank's case.

Handling market fluctuations

Banks will also do a weekly valuation of the securities, and more frequently should the market be characterised by volatility. Consider a customer who approaches a bank with securities valued at Rs 10 lakh against which a loan of Rs 6 lakh is sanctioned. If, during periodic assessment, the bank determines that the market value of the stocks has fallen to Rs 8 lakh (against which the maximum amount that can be given is Rs 4.8 lakh), the customer has to make up for the difference of Rs 1.2 lakh either by pledging additional securities, or by depositing the difference with the bank, assuming that the entire amount originally disbursed by the bank has been used up by the customer. Customers are normally given a fair amount of time to make up for the shortfall. Should they fail to do so, the bank is at liberty to sell the securities in its possession to recover the difference.

Conversely, should there be an appreciation in the value of the securities pledged, the customer would automatically be eligible for an enhancement in drawing power.

Additionally, shares can be pledged from any depository/depository participant (DP) across the country, though if the bank were to double up as your DP as well, the processing would be comparatively faster.

Product suitability

THE question of when one needs to get a product of this nature also needs to be addressed. For instance, if one is confronted with a situation that warrants immediate financial attention, but at the same time is also confident of an assured cash flow a few months down the line, this product can be used to tide over the exigency.

Others would like to use the sanctioned amount to dabble in the stock market (either primary or secondary). This is certainly fraught with a high degree of risk. Unless one is sure of generating a return that is higher than the interest being forked out, this is bound to be a losing proposition. Conservative investors are better off by avoiding this tactic. One also needs to exercise discretion about the stocks to be pledged with the bank.

While all the three banks considered in the write-up have a fairly comprehensive list of approved stocks, one would be better off by pledging defensives, such as FMCG and pharma stocks, and to a lesser extent, commodity/economically sensitive stocks. Technology/media stocks can be avoided for this purpose. With tech stocks witnessing huge price swings in recent times, one's portfolio is likely to undergo substantial erosion should the market witnesses a decline.

If utilised prudently, this product can help unlock the value of securities even during depressed stock market conditions and provide customers with the much-needed liquidity during pressing times.

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