By buld_online 
Picture this, you own a gold necklace and there’s a need for an urgent loan. So, you decide to hand your necklace to the bank as “security” to secure a loan, and if you default, they keep the necklace.
Similarly, in the stock market, promoters (major shareholders) can ‘pledge’ their shares to raise funds. While this might sound harmless, for everyday investors, share pledging can carry hidden risks and opportunities.
What is Share Pledging?
When a company’s promoters or shareholders use their own shares as collateral to borrow money from banks or other financial institutions, that’s called share pledging. Such shareholders may need funds for expansion, paying off debt, or funding other businesses. Instead of selling shares, they pledge them and promise to hand them over if they can’t repay the loan.
Per the Reserve Bank of India (RBI) regulations, a loan-to-value (LTV) ratio of 50% is always maintained when lending based on the stock pledge to manage risk. That means for every ₹200 crore of pledged shares, one can borrow up to ₹100 crore.
But there’s a catch: If the share price goes down, the lender can sell those pledged shares, which could push the stock price even lower and hurt the company’s stability.
Let’s understand this better.
How Does Pledging Work?
Collateral Arrangement: A promoter and a lender sign an agreement. The promoter deposits a certain number of shares into a “pledge account” with the lender.
Haircut Mechanism: Lenders apply a “haircut”—a discount on market value to buffer price swings. If shares worth ₹1 lakh carry a 20% haircut, the loan ceiling becomes ₹80,000.
Loan Disbursement: Based on the current market value of those shares, and after applying a haircut (a discount to protect the lender against price drops), the lender disburses the loan.
Monitoring and Margin Calls: If the share price falls and the collateral value dips below a threshold, the lender may ask the promoter to add more shares or repay part of the loan. This is called a margin call.
Unpledging Shares: Once the loan is fully repaid, the lender releases the shares back to the promoter. If the shareholder fails to repay the loan, the lender has the right to sell the pledged shares in the open market to recover the debt.
Quick Example:
XYZ Ltd. promoters own 60 lakh shares at ₹500 each (total value: ₹300 crore). They need ₹100 crore for expansion. At a 50% LTV, they must pledge ₹200 crore worth of shares—i.e., 40 lakh shares. Any price dip below ₹500 would trigger a margin call to restore the collateral cushion.
Why Promoters Pledge Shares?
Lower Cost vs Equity Dilution: Pledging is often cheaper than raising fresh equity, which dilutes ownership.
Quick Access to Funds: It’s faster than other fundraising routes like issuing bonds or fresh shares.
Flexibility: Promoters can use the funds for various needs, such as new projects, acquisitions, or covering working capital.
How Pledging Affects Investors
Investor Sentiment: Lots of pledged shares can look like the company is in financial trouble, which can be a red flag for investors and drag down the stock price.
Harder to Buy or Sell: When many shares are locked up as collateral, fewer shares are available to trade, making it more challenging to buy or sell without moving the price.
Bigger Price Swings: Stocks with heavy pledging often see sharper ups and downs—any adverse news can hit them harder.
Risk of Forced Sales: If borrowers can’t repay their loans, lenders might dump those pledged shares all at once, pushing the price further down.
Governance Red Flags: High pledging levels can coincide with weaker oversight, raising concerns about how well the company is run.
Overall, when promoters borrow against their shares, it can help or hurt retail investors. If they use the money to grow the business, the stock may rise. But if they can’t repay and the lender sells those shares, the resulting supply glut can drive the stock price down, harming investors.
How to Spot Pledged Shares?
Company Disclosures: Every listed company in India must disclose the percentage of promoter shareholding that is pledged. Look for this in quarterly shareholding patterns on the BSE/NSE websites.
Annual Reports: The “Notes to Financial Statements” section often has details on pledged shares.
Financial News & Analysis Tools: Several stock screeners and financial portals flag companies with high pledge ratios.
Pros and Cons at a Glance
Final Thoughts
Share pledging isn’t inherently bad—it’s a legitimate tool for promoters to raise capital. But for investors, understanding the extent and implications of pledged shares is crucial. By keeping an eye on pledging levels, reading company disclosures carefully, and diversifying your holdings, you can protect your portfolio from the hidden risks that share pledging can bring.
Disclaimer: The information provided in this article is for informational purposes only and is not intended as financial, investment, or professional advice. Readers are encouraged to seek independent advice before acting on any information contained in this article. Smallcase Technologies Private Limited disclaims any responsibility for actions taken based on the content of this publication.