Why You Should not take Loan Against Stocks

| December 18, 2013

Why You Should not take Loan Against Stocks or equities.

Equities might be a good long-term investment avenue. However, they do not give much pleasure if you want to pledge these to raise money. While banks do extend loans against shares, they have several conditions for doing so.

Most don’t give more than half of the value of the security. So, if you want a loan of Rs 5 lakh, you should have securities worth at least Rs 10 lakh to pledge. These have to be scrips of top-rated companies. Even if the bank does not insist for shares of a particular company, it could agree to sanction the loan only if the company has a triple-A rating.

The list of such stocks is small. So, if your portfolio consists of largely small-cap companies, you might find raising funds against these quite tough. “We prefer stable companies because the stock market is volatile and prices see huge fluctuation. In case prices decline, we only have these shares to fall back on to recover our money,” says the head of retail loans of a public sector bank.  As against this, banks prefer to lend against property; in such loans, this is a collateral. And, usually, the property price is likely to move upwards, taking care of any risk the bank faces in case of non-repayment.

This is not the case with loans against shares, which is why banks are not keen on it. Mahesh Dayani, country head, retail assets, ING Vysya Bank, says the bank does offer loans against securities, primarily against multiple scrips. “We generally don’t lend against single scrips and look at the cases on an exceptional basis,” he says. This is a hedge for the bank in case the price of that one particular share dips sharply. While ING Vysya mainly gives loans against shares as an overdraft, some banks offer it as a term loan. The advantage of an overdraft is that the borrower has to pay interest only for the amount utilised.

In the case of a loan against property, not only will you get a larger amount, of about 65 per cent of the property value, but the interest rate is also about 100 basis points lower than a loan against securities. However, it could be more time-consumiing, since the bank will verify all the property documents and carry out a valuation before sanctioning the loan. As compared to this, a loan against securities could be faster. According to Adhil Shetty, chief executive of Bankbazaar.com, one of the biggest drawbacks in the case of a loan against shares is the low loan to value (LTV) ratio. “While loans against shares are cheaper than personal loans, the low LTV is a big negative. Another restriction is in terms of the companies’ set of shares the bank will accept. So, these loans could prove to be quite cumbersome,” he says.

In many cases, the end use of the loan is also a concern for the bank. Most will insist on an undertaking from the borrower that the money will not be used for speculative purposes.

Category: Finance Ministry

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