What is Pledging of Shares? Why it is Dangerous for Investors?

What is Pledging of Shares? – The pledging of shares is one of the many crucial aspects to look at when researching firms to invest in and is sometimes disregarded by investors. The shareholders may have reason for worry if a large number of shares are pledged. In this piece, we’ll go through what precisely constitutes pledging of shares and why having a lot of shares pledged might be problematic for investors.

What is Pledging of Shares?What is Pledging of Shares?

This is going to be a fascinating piece, and I have no doubt that you’ll learn a lot of new stuff about share pledges from it. Consequently, be sure to read this article through to the conclusion. Let’s start now without wasting any more time.

 

1. What does stock pledging mean?

In plain English, pledging shares refers to borrowing money against the shares that one owns.

Securities are regarded as assets. The promoters of a firm may get loans to cover their personal or professional needs by pledging their shares as collateral to lenders. Shares may be pledged to cover a variety of expenses, including personal responsibilities, working capital needs, financing for other projects, making new purchases, and more.

2. What Motivates Promoters to Pledge Shares?

As was previously said, the promoters pledge their shares in order to fulfil different professional or private obligations.

Share pledges are often the promoters’ final resort for raising money. Promoters may raise money more safely by either taking on debt or equity capital. But if the promoters want to pledge their shares, it suggests that all other avenues for generating money have been exhausted.

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These circumstances take place while the economy is struggling. Shares may be used as collateral to get loans from banks since they are assets owned by promoters.

3. Why is it dangerous for shareholders to pledge their shares?

The promoters utilise their ownership as collateral when pledging shares to get secured loans. In a bull market, when prices are rising and investors are confident, pledging shares may not present many problems. The issue, however, appears during a bear market or a downturn in the economy.

The value of the collateral (against the secured loan) similarly fluctuates along with the share price as the price of stocks does. However, the promoters are often expected to preserve the collateral’s value.

Now, the value of the collateral will decrease if the share price drops. The promoters must make up the gap by either contributing more money or pledging more shares to the lender in order to offset the difference in the collateral value.

In the worst event, the lender may be able to recoup their funds by selling the pledged shares on the open market if the promoters are unable to make up the shortfall. The contract between the lenders and the promoters stipulates this minimal collateral amount. Therefore, if the value drops below the minimum value, it provides the lender the right to sell the pledged shares.

4. What are the Pledged Shares Risks for Retail Investors?

In general, when lenders sell shares that the company’s promoters have pledged as collateral, the stock price might decline significantly. Due to the public’s panic selling, this might lead the collateral value to further decrease.

Additionally, the lenders’ sale of the shares they had pledged could alter the company’s shareholding structure. Due to their decreased shareholdings, the promoters’ capacity to vote and make important choices may be impacted.

Additionally, if the value of the shares continues to decline, pledging them might be disastrous. This is due to the promoters’ ongoing need to pledge more shares to make up the shortfall in the collateral value.

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5. Where can I locate shares that Indian firms have pledged?

You may use any of the two ways listed below to determine the pledged shares for any publicly traded Indian business.

MODEL 1:

On the BSE or NSE website, you may discover the pledged share as a proportion of all holding shares. Companies that are publicly traded are required to report their quarterly shareholding structure to the stock markets. As a result, the BSE/NSE website has the most recent information on their ownership structure.

The specific processes to locate the pledging of shares for Indian public firms are shown below.

  • Visiting the BSE India website
  • Use the top search box to look for the business name.
  • On the corporate page’s left sidebar, choose the “Shareholding Pattern” option.
  • Open the shareholding pattern’s most recent quarterly report.
  • The holdings summary for the given securities is available.

Here is Suzlon Energy’s ownership structure for the March 2021 quarter as an example. Please take note of the promoters’ present pledge of shares (88.54 percent).

MODEL 2:

On Trade Brains Portal, you may access the most recent ownership structure and pledged shares of any publicly traded business in India. Finding the committed shares using this approach is much quicker and simpler.

The following are the methods to use Trade Brains Portal to locate shares that have been pledged:

  • Visit the Trade Brains Portal.
  • Open the company page by typing the business name into the top search box.
  • Find the shares that have been pledged by visiting the section on shareholding patterns.

Here is an example of Suzlon Energy’s ownership structure from the Trade Brains Portal. Here, you can see that the promoters’ pledged shares for the quarter ending March 21 equal 88.54 percent.

6. In conclusion

Shares are often pledged in businesses when the promoters own a substantial portion of the stock. As a general rule, promoters should avoid committing more than 50% of their shares.

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To prevent needless problems, never do business with firms that have a lot of shares pledged. This is due to the fact that stock pledges are an indication of a company’s weak cash flow, low creditability, large debt, and inability to satisfy short-term obligations. (If the promoters have committed a significant portion of the shares, it is usually good to learn why.)

In any case, a declining share pledge rate over time is positive for investors. On the other side, a rising share pledge might be risky for shareholders and promoters both. If the share pledge is not gradually decreased, even top-notch enterprises may suffer.

However, corporations are not always harmed by share pledges. It happens often that businesses use the loan from pledged shares to develop new, profitable goods, services, etc. that turn around the business. The company’s willingness to pledge shares is not a major worry if it has a growing operational cash flow and promising future prospects.

Here, pledge of shares aids in business growth or the implementation of new initiatives that generate more money in the future. Additionally, it should not be seen negatively when 5–10% of shares in fundamentally sound corporations are pledged. Small pledged shares may be handled effectively. The issue arises, nevertheless, when the pledge rises excessively.

The bottom line is to attempt to steer clear of corporations that have large (or rising) share pledges.

That concludes this post. I hope you found it useful. Invest wisely!

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