What is Pledging of Shares? Why Do Investors Pledge Shares?

Pledging of Shares: An Overview

When finalizing the best stocks to invest in, the pledging of shares is an important factor to consider, which most investors either ignore or have no idea about. It is important to understand that highly pledged shares can be very risky for your investment. In this article, we will discuss everything you need to know about the pledging of shares, including the pledge share meaning, how it works, why it is risky, and more. Keep reading!

What Is Pledging of Shares?

Let’s begin with what pledge means in the share market. 

In simple terms, a pledge of stock or share pledge means using shares as collateral and taking a loan against them. Shares are basically the assets of the company or a shareholder. And pledging is a way by which the promoters of any company take a loan against the held shares to meet these personal or business requirements including fulfillment of capital requirements, expansion of business, starting a new venture, and so on. 

Why Promoters Pledge Shares?

As mentioned above, promoters pledge shares with the objective to meet a variety of financial requirements. Generally, share pledging is treated as a last option to raise capital or funds in emergency situations. For promoters, raising funds through this method is safer than taking debtthe . Thus, the important point to note is, if a promoter is pledging his shares, it means he is left with no other option to raise funds. Such situations usually occur in the phase of economic slowdown. Banks lend loans by keeping shares as collateral because they are the assets of promoters who are borrowing the loan. 

This was about pledging of shares by the promoters. But why do investors pledge stocks? Let’s figure it out!

Pledging of Shares: Why Do Investors Do It?

As simple as that, shares pledging enables investors to trade higher volumes of shares. When investors buy shares, their savings are held in their trading or derivative accounts in the form of shares. Even after they have shares as assets, they can’t use the locked fund for a new trade. This is the reason why investors pledge their shares in their trading accounts. 

Is Pledging of Shares Risky for Shareholders?

At the time of the share pledge, company promoters use their stock or shares as collateral to take loans as per their requirements. Note that pledging of shares during a bull market doesn’t cause any problems because the market is moving in a positive direction and as a result investors are stress-free. 

The main problem arises during the bear market when the market is moving downward and investors enter panic mode. 

Because the stock prices keep fluctuating, the value of collateral against which loan is taken also keeps changing. However, many times the promoters are required to maintain the collateral’s value. And if the stock prices fall further, the value of collateral starts diminishing. So, to maintain this value, promoters either pay in cash or pledge more shares to their lender. 

In the worst-case scenario, if a promoter fails to fill the difference, the lender starts selling pledged shares in the market to recover their amount. Thus, promoters lose their shares. 

Is Pledging of Shares Risky for Investors?

As you may already know, the prices of stocks depend heavily on the news and rumors in the market. So, stock prices can fall increasingly in response to the news that lenders (banks or other financial institutions) are selling the shares pledged by promoters openly. This can result in a decrease in the value of collateral because the public starts selling the shares in a panic. Moreover, the selling of pledge shares by lenders can also change the shareholding pattern of the organization. This directly impacts the voting rights of the candidates as they are left with a few shares. In short, it impacts their authoritative power   

And if the share price continues to fall heavily, it can create never-ending havoc. This is because the promoters have to pledge more and more shares in order to balance out the collateral value. 

Key Takeaways

We have discussed everything about the share pledge meaning. Here are some important takeaways from the article:

• Shares pledging is mostly seen in companies in which the shareholding of promoters is very high. As a general rule of thumb, if the share pledging is more than 50%, it is going to be risky for the promoters. Therefore, always avoid investing in companies with high share pledges to avoid any risk. In a nutshell, pledging shares is a sign of low credibility, poor cash flow, inability to meet necessary requirements, and high debt. 
• However, if you find a company whose pledged shares are decreasing over a particular time, then it’s a good sign. But an increasing number of pledging shares can be very dangerous for both the investors as well as promoters.
• Pledging of shares is not always a negative point for companies. Most of the time, pledging shares allows companies to come up with remarkable products, services, and new ventures using the loan amount they have secured. If a company has a good cash flow and is performing well, then pledging doesn’t cause any financial disturbance. 

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