Home Finance What is Share Pledge? Why is it dangerous for investors?

What is Share Pledge? Why is it dangerous for investors?

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Understanding what is pledged shares or pledged shares: When examining stocks to invest, pledging shares is one of the most important factors that are often overlooked by many investors. Pledge of shares can be a matter of concern for the shareholders. In this post, we are going to discuss what exactly pledging shares is and why high pledged stocks can be a hassle for investors.

This is going to be an interesting post and I am sure you will learn many new things related to pledging of shares in this post. So make sure to read this article till the end. Now, without wasting much time, let’s get started.

1. What is Pledge of Shares?

In simple words, pledging of shares means taking loan against the shares held by someone.

Shares are considered assets. Pledge of shares is a way for promoters of a company to obtain a loan to meet their business or personal needs by placing their shares as collateral for lenders. Pledge of shares can be used to meet various requirements such as working capital requirements, to finance other ventures, to make new acquisitions, personal obligations and much more.

2. Why do promoters pledge their shares?

As discussed above, promoters pledge their shares to meet various business or personal requirements.

Usually, pledging of shares is the last option for promoters to raise funds. It is comparatively safer for promoters to raise funds by taking equity funding or debt. However, if the promoters are expecting their shares to be pledged, it means that all other fund raising options have been closed.

These situations occur during economic downturns. Since shares are assets that are held by promoters, it can be used as security for taking loans from banks.

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3. Why is pledging of shares risky for the shareholders?

While pledging the shares, the promoters use their stake as collateral to obtain a secured loan. During a bull market, pledging shares may not pose many problems as the market is trending upward and investors are optimistic. However, the problem arises in a bear market or an economic downturn.

As the share price fluctuates, the value of the collateral (against the secured loan) changes with the change in the share price. However, in most cases, promoters are required to maintain the value of that collateral.

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Now, if the price of the shares falls, the value of the collateral will also decrease. To meet the difference in collateral value, the promoters will have to make up the shortfall either by providing additional cash or by pledging more shares to the lender.

Collateral value (at the time of taking loan) Collateral value after a 30% drop in share price Collateral value after a 50% drop in share price
real time value 100 crore 70 crore 50 crore
Comment no issue Over pledge of shares to cover the balance difference of 30 crores Over-pledge of shares to cover the balance difference of 50 crores

In the worst case, if the promoters fail to make up the difference, the lender can sell the pledged shares in the open market to recover their money. This minimum collateral value is agreed upon in the contract between the lenders and the promoters. Therefore, it entitles the lender to sell the pledged shares, if the value falls below the minimum value.

4. What is the risk for retail investors in pledged shares?

In general, the share price may be weighed down on news that lenders are selling shares in the open market that have been pledged by the company’s promoters. This could result in a further fall in the collateral value due to panic selling by the public.

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In addition, the sale of pledged shares by the lenders may also change the shareholding pattern of the company. This may affect the voting power of promoters as they now have fewer shares and their ability to make important decisions.

Furthermore, pledging the shares could spell a disaster if the share price continues to fall. This is because the promoters have to continuously pledge more shares to cover the difference in collateral value.

5. How to find out pledge of shares for Indian companies?

You can get the shares pledged for any of the public Indian companies by using either of the two methods mentioned below.

Method 1:

You can view the pledged shares as a percentage of the total holding sharing shares. BSE or NSE website. Publicly listed companies are obliged to submit their quarterly shareholding pattern to the stock exchanges. Hence, you can get the latest information about their shareholding pattern on BSE/NSE website.

Here are the exact steps for pledging shares for Indian public companies.

  1. Go for BSE India Website.
  2. Search the company name in the top search bar.
  3. Click on the ‘Shareholding Pattern’ tab on the left sidebar of the company page.
  4. Open the latest quarterly report of shareholding pattern.
  5. You can get summary details of specified securities.

For example, here is Suzlon Energy’s shareholding pattern for the March 2021 quarter. Please note the current pledge of shares (88.54%) by the promoters.

Pledge of Shares BSE Suzlon Energy Business Mind

Method 2:

You can get latest shareholding pattern and pledged shares of any public company in India on Trade Brains portal. It is a comparatively easier and faster way to find pledged shares.

Here are the steps to find out where the shares are pledged using the Trade Brains portal:

  1. Go for business mind portal
  2. Search the company name on the top search bar and open the company page.
  3. Go to the shareholding pattern section and find the pledged shares.

For example, here Shareholding Pattern of Suzlon Energy On the Business Minds Portal. Here, you can see that the shares pledged to the promoters are as high as 88.54% for the March 21st quarter.

Pledge of Shares Business Mind Portal Suzlon Energy

Read also: How to find the complete list of listed stocks in Indian stock market?

6. Bottom Line

Pledge of shares is generally seen in companies where promoters have a high shareholding. As a general rule, pledging more than 50% of the shares can be risky for promoters.

Always ignore companies with high pledge of shares to avoid unnecessary hassles. This is because pledging shares is a sign of poor cash flow, a high-debt company with low creditworthiness and an inability to meet short-term requirements. (If the promoters have pledged a high percentage of the shares, it is always worthwhile to know the reason.)

Anyway, falling stocks over time is a good sign for investors. On the other hand, pledging of shares can be dangerous for both the promoters and the shareholders. If pledging of shares is not reduced over time, then quality companies can also become victims of this.

Still, pledging shares isn’t always bad for companies. Many times, companies are able to come up with new winning products, services, etc. that transform the company by using loans from the pledged shares. If the company’s operating cash flow is growing and has good future prospects, then pledging the shares is not a big concern for them. Here, pledging of shares helps in expansion of the company or completion of new projects which result in increase in revenue in future. Moreover, pledging 5-10% of shares in fundamentally healthy companies should not be considered as a problem. Small pledged shares can be managed efficiently. However, the problem arises when the mortgage becomes too high.

Anyway, the bottom line is to try to avoid investing in companies with a high (or rising) mortgage of shares.

That’s all for this post. I hope it was helpful for you. Happy investment!

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Disclaimer: The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of knews.uk and knews.uk does not assume any responsibility or liability for the same.

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