“Sometimes your pledges become your problems.” ― Amit Kalantri

What is the Pledging of Shares? 

Pledging of shares simply means taking the loan against the shares one holds. Both the investors and promoters can take the loan against the shares held by them. After taking the loan the shares held by them are freeze by the lender and they cannot sell them until the lender gets the payment back with interest levied.

In this process of pledging shares, the investors or promoters must maintain the value of collateral with the lender, and any shortfall in the price of shares gives a margin call to investors or promoters to add money or pledge more shares. If the investor or promoter is unable to add the money or pledge more shares, then the lender has the full right to sell the shares in the market to recover the money.

How does Pledging of Shares Work?

Let us try to understand the pledging of shares with an example.

There exist a company X who wants a loan for its next plan and they are willing to pledge promoter’s shares for the same. The current market price (CMP) of the share is Rs 1000 and company X needs a loan of 1 crore.

The banks usually offer loans up to 50% of the market price of the share. In this case, if company X pledges its one share then the bank will offer the loan of Rs 500. In such a scenario the company X must pledge 20 thousand shares with the lender.

For security purposes, the lender keeps the difference between the current market price and the loan amount.

According to the rules and regulations led by RBI, LTV (Loan to Value) ratio of 50% must be maintained at all the time when lending is based on the pledging of shares. Since the proposed loan amount in the above example is 1 crore, the promoters must pledge 2 crores worth of shares. It is important to maintain a 50% LTV ratio and if such a scenario occurs where 50% LTV ratio is not maintained then a time of 7 working days is given to promoters else the lender has the right to sell the shares and recover the loan amount.

Why promoters pledge their shares?

*Promoters might pledge their shares for personal needs, investment into new ventures or acquisition of the existing business, or to meet the working capital requirements. 

*Sometimes promoters of the company feel that price of the stock is undervalued and to increase the number of shares they pledge their shares so that they can buy more shares from the secondary market. 

*To raise additional funds for the company, promoters might pledge their existing shares as collateral.

*A promoter who is interested in buying the shares by exercising warrants might want to pledge the existing share to raise the fund.

Effects of Pledging of Shares 

Pledging of shares work as collateral but instead of house or gold, the shares of the listed companies are pledged. Anyone who owns a share of a listed company can pledge the share and obtain a loan in case of promoters from banks and financial institutions and good margin in case of retail investors from their brokers. Whenever the promoters of a company are pledging their shares then an official notice is sent to the investors.

One can look for complete details of pledged shares on the official website of NSE and BSE. The data for the pledged shares is available in the shareholding pattern section for each company and this data will be published once every quarter as per the rules and regulation of SEBI.

Pledging of shares is the standard way of accumulating funds for the company but the negative experience of the past have created a bad impression about the instrument as it signals a credit crunch in the company, poor cash flow in the company and it tells about the promoters inability to meet the working capital requirements.

Risk of Retail Investors for Pledging by Promoters

If promoters are unable to keep the LTV ratio then the lenders can sell the shares in the open market. Prices of those shares fall heavily on such news where lenders are selling the shares that are pledged by the company’s promoter. This results in a further decline in the value of collateral because of panic selling by the public.

Whenever the lender sells the pledged shares then there arises a change in the shareholding pattern of the company. The ability to make crucial decisions & Voting power of promoter is highly affected because they are holding fewer shares now.

Pledging of shares can be disastrous if the share price of the company falls continuously. This is because of the rules & regulations that promoters must consistently pledge more shares to cover up the difference else lender has the right to sell the share in the open market.

What are the steps involved in finding pledging of shares for Indian Public Company?

1. Visit the BSE India Website. (www.bseindia.com) 

2. Search for the Company Name in the Search Bar at the right top corner. 

3. Click on the Shareholding Pattern of the Company. 

4. Open the latest Quarterly report of the Company. 

5. You can easily find the latest holding pattern of the specified securities.

Key Takeaways