What Is Pledging Of Shares?

A company’s product and services, management quality, valuation multiples, stock price history, etc., may be among some factors one considers while picking stocks. However, an essential factor an investor may miss out on or not know much about is pledged shares. The amount of pledged shares would indicate the risk associated with the stock, and therefore essential to understand.

In this article, we have covered what pledged shares are, why promoters and investors pledge shares, when pledging shares becomes risky and whether pledging shares is good or bad. 

What Is Pledging Of Shares?

Pledging of shares means putting one’s shares as collateral to get secure loans and fulfil financial needs. Collateral is an asset put in by the borrowers to protect the lender’s interest. If the borrower, for any reason, fails to repay the loan, the lender can seize the collateral to recover the dues.

Why Promoters Pledge Shares?

Promoters can be individuals, firms, or a group of people engaged in setting up a business and carrying out the formalities required for setting up the business. Shares owned by promoters act as assets for them. Therefore, they may use shares as collateral to take loans and meet financial requirements such as working capital requirements, funds for expansion, acquisitions, etc. Such shares are called pledged promoter holding.

By pledging shares, promoters may use locked-in funds, retain ownership, and avail of loans to fulfil their financial requirements. Though, acquiring funds by issuing debt or equity is believed to be less risky than pledging promoters’ shares. So, promoters may only pledge their shares when they do not have other ways left to raise funds or if they need funds immediately.

Pledging Of Shares: Why Do Investors Do It?

When investors purchase shares, their savings convert to shares and thus get locked into their trading accounts. Although such funds helped shareholders buy assets in the form of shares, the same funds are unavailable for a new trade. Here is where the importance of share pledging comes in.

Pledging of existing shares allows investors to borrow additional funds using already locked-in funds, thereby enabling investors to take up more trades. When brokers lend investors additional funds against existing shares in their portfolio, it is known as margin against shares.

When Does Promoter Pledging Of Shares Become Risky?

Bear market

As the stock prices keep changing, the value of shares pledged as collateral also keeps changing. Promoters pledging shares in a bull market may not be a major concern because the value of pledged shares is likely to increase, and they would be able to maintain the collateral value. If promoters are pledging shares in a bear market, that may be a cause of concern.

For instance, suppose the promoters took a loan of ₹50 crores by pledging shares of the same worth. In the bear market, if the value of pledged shares falls to ₹47 crores, the promoters would have to either pay cash or pledge more shares.

Discover stocks that suit certain filter criteria and dive into details to check their WealthBaskets.

Company’s poor financial condition

If the company has sound fundamentals and a strong cash position, promoters pledging shares may not be a significant sign of concern. But, for companies with poor fundamentals and weak cash positions, promoters pledging shares can indicate financial problems in the company.

In either case, if promoters fail to maintain the collateral value, the lender would sell pledged shares in the open market to recover the dues. Due to decreased promoters’ shareholdings and infusion of additional shares in the market, the stock price may fall further.

When Does Pledging Of Shares Become Risky For Investors?

As mentioned earlier, the share prices keep changing. Especially news and rumours significantly affect stock prices. So, when investors know about lenders selling shares pledged by promoters in the open market, the stock price may fall. As a result, the public may start selling in panic, resulting in decreased collateral value.

Plus, the shareholding pattern of a company also changes when lenders sell pledged shares. It also impacts the voting rights of promoters and, ultimately, their decision-making and authoritative power. 

Thus, investors’ overall returns from investments can get affected.

Pledging Of Shares: Good Or Bad?

Pledging of shares is not necessarily always bad. The companies may use the loan taken against pledged shares to fund ventures, expansion, new acquisitions, or to improve goods and services. 

If the company’s cash flow is healthy enough to keep up the collateral value, pledged shares may not harm. But, if the cash flow is poor and promoters cannot maintain collateral value, the pledged shares may prove disastrous for the company’s financial conditions.

WealthDesk makes investing easier for you by helping you invest in WealthBaskets. WealthBaskets are idea, theme, or strategy-based combinations of stocks and ETFs built and closely monitored by SEBI-registered professionals.

FAQs