The system of ‘Udhaar’, or credit offered by local Kirana stores to their customers is widely prevalent across India. The local mom-and-pop stores trust their customers, allowing them to purchase on credit and settling the payment at convenience.
Doing this enables the Kirana storeowner to retain and build his clientele. Customers too prefer this convenience of not having to pay upfront at the time of purchase. The easy access to credit and hassle-free repayment options prove beneficial to patrons.
This is probably a reason why the neighbourhood grocery store has proved extremely durable against swanky supermarkets and their technology driven peers.
Udhaar against stocks
Imagine availing a credit facility against your investments. When an investor borrows cash from his broker against stock investments, it is known as going on margin.
Margin Funding is a line of credit provided by your broker against your stock investments. This facility can be accessed by all types of clients, irrespective of whether you are a retail investor, HNI or corporate entity.
This service offering provides you with an opportunity to invest more than you could, had you used your own money, and increase the potential returns. The broker grants the credit against a pre-approved list of securities. The buying power changes on a daily basis and depends on the price movement of the marginable securities.
While the credit provided by your local kirana store may be cost-free, Margin Funding provided by your broker is available at a small cost. The interest rate applied by your broker is usually lower than that of personal loans or credit cards.
Do not confuse Margin Funds for trading with Loan against Shares. The latter is an overdraft facility against your shares held in your demat account. The amount of loan that can be availed is defined by a Loan to Value (LTV) ratio, which is a percentage of the share value. Thus, if the LTV is 50%-70% of the stock value, you can avail a loan of Rs 5-7 lakh against stocks worth Rs 10 lakh.
Loan against Shares usually come with additional charges such as processing fees, one-time fee, renewal charges, among others which need to be considered carefully before availing of the loan.
Both Margin Finance trading and Loan against Securities is granted against pre-approved list of securities. Through margin finance facility, investors can raise finance to purchase additional securities without selling their long-term investments.
Benefits of Margin Finance
- Instant Liquidity
Margin Finance options give your access to instant liquidity that is essential for short-term borrowing requirements. You can avail of the credit without selling the securities. With easier and faster processing, you can leverage existing funds, usinch you can capitalize on new investment opportunities.
- Boost Returns
Margin can amplify returns when used by a disciplined and experienced investor. Use it if you wish to buy more shares of a stock idea you are certain is the next big winner but do not have sufficient cash in your wallet.
How can you use margin funding to multiply your returns?
For example, let’s assume you buy 1,000 shares of a Rs 200 stock with Rs 2 lakh in cash. If the stock goes up to Rs 300, your profit will be Rs 1 lakh or 50%.
Had you used Rs1 lakh in cash and Rs 1 lakh from a margin loan to buy the same stock, then your return would work out to Rs 1 lakh, minus the interest on the margin loan. Thus, your investment of Rs 1 lakh would have nearly doubled.
However, if the stock moved in the opposite direction, if would lead to deep losses. Hence, use this option wisely.
The most common risks associated with margin finance is Margin Call (i.e. reduction in loan to security value ratios) which occurs as a result of market volatility and/or high gearing ratios.
Risks can be minimized if:
– The investment portfolio is diversified across number of sectors and across the large caps and midcaps to reduce the risk of fall in one particular sector.
– The portfolio is evaluated and churned regularly by booking profits and keeping stop losses.
- Low Interest Costs
Margin finance comes at a lower interest cost. The lending rates can vary between 15%-18% p.a. which is applicable only on the credit availed and for the period utilised. This is much lower than the interest rates for unsecured such as Personal Loans and Credit Cards, where the interest rates are often north of 24%. In addition, these unsecured loans will involve other charges such as processing fees, foreclosure charges etc.
- Uninterrupted Corporate Benefits
By availing of a loan against your securities, you not only retain the ownership but also continue to avail of corporate benefits such as dividends, bonuses, rights, etc. Thus, you effectively kill two birds with one stone—retain your shareholder rights and using the credit against your securities for your short-term finance requirements.
You can repay as per your convenience, as this facility is in the nature of an overdraft facility. No prepayment charges are charged. Interest is charged only for the days the loan amount is utilized. So long as your line of credit does not exceed your margin maintenance requirement, you can pay back your loan on your own schedule.
Any appreciation in the value of the securities given as margin would automatically allow enhancement in drawing power.
Thus, for borrowers having a sufficient repayment capacity and a short time span of funding requirement, loans against shares offer an attractive option. However, one must carefully consider their cash flow situation and market conditions before opting for loans against shares.
Prabhudas Lilladher Financial Services Pvt. Ltd. (www.plindia.com) is an RBI-approved NBFC arm of PL group. It offers margin funding, loan against shares & securities to meet fund requirements of various categories of borrowers.
For more information on PL’s Margin Funding services, contact:
- Pan India: Mr. Parag Paigankar
- Plfunds@plindia.com | 022-66322308/66322304/66322440