All You Need to Know About Securities Lending and Borrowing

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Securities lending and borrowing (SLB) is a vital aspect of the financial landscape that plays a pivotal role in maintaining liquidity and facilitating various investment strategies. This intricate financial practice involves the temporary transfer of securities from one party to another, providing unique opportunities for investors and institutions alike. In this comprehensive guide, we will delve into the intricacies of securities lending and borrowing, exploring its mechanisms, benefits, risks, and the crucial role it plays in the broader financial ecosystem. Whether you are a seasoned investor or just beginning to navigate the complexities of the financial markets, this blog aims to equip you with a comprehensive understanding of securities lending and borrowing.

Defining Securities Lending and Borrowing

The practice of securities lending and borrowing allows traders to either borrow or lend shares from other market participants.

  • In the context of hedging, this technique provides a robust alternative to the derivatives market.
  • Short-sellers or borrowers in the SLB market are traders seeking to sell shares they do not own. Conversely, lenders are shareholders with long-term holdings in shares that are inactive in their demat accounts.
  • The interim loan of securities from a lender to a borrower is referred to as securities lending, contributing to enhanced liquidity and improved market efficiency in the equity market.

Working of Securities Lending and Borrowing

Securities lending and borrowing is an authorised method for lending and borrowing securities. The rules were created by SEBI in May 1997, and their most recent revision was made in November 2012.

  • Every market participant in the Indian securities market, including consumers (apart from eligible foreign investors), has been permitted to rent and borrow securities, but only through a licensed agent.
  • There are just two approved intermediates at this time: NCL (NSE Clearance Limited) and BOISL (BSE Clearing Corporation).
  • The majority of deals go to NCL, which is preferred.

Features of Securities Lending and Borrowing Mechanism (SLBM)

Securities lending is crucial to short selling, in which a trader borrows securities to sell them rapidly. The borrower expects to profit by selling the security and then repurchasing it at a lower price.

  • Since clearing corporations cover transactions in the SLB area, they are free of counterparty risk.
  • Over 370 stocks are available on the NSE SLB platform as of 20 August 2018.[1]  (this list is updated by NSE on a monthly basis).
  • There are contracts provided with lengths ranging from one month to 12 months.
  • Neither the Securities Transaction Tax (STT) nor SEBI’s turnover fees are applicable.

Benefits of Stock Lending and Borrowing

For a Lender

  • SLB offers lenders an extra return on their idle assets.
  • Lenders can lend out their shares, such as 1,000 shares of QRS, when not actively holding them.
  • Loan costs are paid to the lender, especially when National Securities Clearing Corporation Limited (NSCCL) acts as the insurer.
  • Lending securities provide an opportunity for additional revenue from the price paid by the borrower.
  • It serves as a technique to broaden one’s perspective.

Additional Revenue Generation

One of the primary benefits of stock lending for a lender is the opportunity to generate additional revenue. Lenders earn fees from borrowers in exchange for lending their securities. These fees can vary depending on factors such as the demand for the specific stock, market conditions, and the terms of the lending agreement.

Enhanced Portfolio Returns

SLB in the stock market allows lenders to put their idle securities to work, potentially earning returns that would not be possible through traditional buy-and-hold strategies. Instead of leaving securities dormant in their portfolios, lenders can earn fees, which can improve the overall return on their investment portfolios.

Risk Mitigation

Despite the temporary transfer of ownership, the lender retains ownership of the securities, which means they continue to benefit from any dividends, interest payments, or capital gains associated with those securities.

Diversification of Revenue Streams

SLB in the stock market provides lenders with an additional source of revenue that is distinct from their core business activities. This diversification can help financial institutions and institutional investors reduce their reliance on a single revenue stream, making them more resilient to market fluctuations and economic downturns.

Improved Liquidity Management

Lenders can recall their loaned securities at any time, subject to the terms of the lending agreement. This flexibility allows lenders to respond to changing market conditions and liquidity needs. In times of high demand for a particular stock, lenders can recall their securities and potentially benefit from increased market prices.

For the Borrower

  • Enables borrowers to engage in activities like short selling.
  • Provides investors with new perspectives on the market.
  • Enhances overall market liquidity.
  • Growing market liquidity leads to tighter spreads, benefiting all market participants by reducing the gap between bid and ask prices.

Lending and Borrowing Stocks

Lending Stocks

  • The lenders in SLBM are usually big insurance firms, mutual fund houses, banks, high net-worth individuals (HNIs), etc.
  • A lender may ask a stockbroker to place orders in his system to lend his stocks using the SLBM.
  • One can specify the details of shares included in the SLBM, like the quantity, the upper limit of market price, the client’s code, etc.
  • Lenders also need to mention the fees they expect.
  • This fee is applicable on the basis of each share transacted. In the event of a default, the lender must submit 25% of the amount lent as security.
  • The lender must receive the due margin amount after transferring the stock to the respective borrower. If a transaction gets cancelled, the trader has the stock itself.

Borrowing Stocks

  • For the borrowers, SLBM works by giving them a chance to get the stocks for an arbitrage.
  • They can use them for short selling or to avoid actual share settlement.
  • Investors or traders taking a bearish stand on a stock get the opportunity to sell the borrowed stock.
  • Borrowers will have to place orders with a stockbroker. They shall have to specify the time period, number of shares, and the lending fee they are comfortable with.
  • When the broker finds an appropriate match for the concerned order, borrowers have to deposit 125% of a stock’s price as the margin.
  • After borrowing, an individual may sell it leaving behind 25% of the total of 125%.
  • The daily mark to market (MTM) on the margin amount helps in avoiding defaults.

Conclusion

Securities lending and borrowing is a financial practice that allows traders to borrow or lend shares from other market participants. This process not only provides an additional avenue for lenders to earn returns on their idle assets but also opens up opportunities for short selling for borrowers. Beyond individual benefits, SLB contributes to market liquidity, fostering efficiency and tighter spreads, ultimately creating a more dynamic and accessible trading environment for all market participants. As we explore SLB, it becomes evident that this practice is a multifaceted tool with implications for investors, short-sellers, and the broader market landscape.

Frequently Asked Questions (FAQs)