All You Need To Know About Stock Lending And Borrowing Mechanism

Have you heard of the ‘Buy and hold’ investment philosophy? You buy stocks and simply forget about them through your lifetime. Over a period of time, you expect the stocks’ value to rise as the companies grow and the economy prospers. There’s no concept of checking if the stocks are valued appropriately, or calculating the right levels to book profit, or even portfolio rebalancing.

This investment style relies on the two key aspects—the steady flow of dividends and the inherent belief that the stocks will grow over time without needing any monitoring.

Now let’s add one more factor to the mix.

What if the investor were to earn an additional stream of earnings from the stocks s/he holds? Imagine, they were to ‘lend’ the stocks to borrowers and earn an ‘interest’ income—just the way banks do when they sell loans. The best part would be that they would continue to remain owners and even earn dividends and stock bonuses if any. This is possible under ‘SLBM’.

What Is The Stock Lending And Borrowing Mechanism?

Simply put, this is a mechanism where you ‘lend’ your shares to market participants in exchange for an interest. Alternatively, you can ‘borrow’ shares from other lenders to play in the intraday trading market. Borrowers mostly use SLBM for activities like ‘short-selling’ or ‘hedging’.

Who can use SLBM?

• If you have stocks lying idle in your account for a long time. You can offer to lend these stocks under SLBM and earn an interest fee.

• If you want to enter into short-sell trades in stocks that you otherwise don’t own. These are trades when you sell a stock at a high price when you expect the market price to fall later in the day. When it does so, you buy back the stock and close the position. You can then ‘return’ the stocks you borrowed.

• If you want to hedge across segments. For example, let’s say Stock X is trading at Rs 100. However, its futures contract is available at Rs 95. You may then want to sell Stock X in the cash segment and buy in the Derivatives segment to pocket the difference of Rs 5 as profit. Such trades are also called as ‘arbitrage’ trades.

• If you want to take up ‘pair trading’. This is when you buy a security at a lower rate and sell another security at a higher rate. The difference between the two trades can you pocketed as your profit.

What’s in it for the lender?

In many ways, it’s all gain and no loss. The lender gets to earn an income without losing ownership or giving up on other gains. Moreover, there aren’t any risks involved too.

Are There Any Risks Involved with SLBM?

No, there aren’t any risks involved with SLBM. This is because every transaction is guaranteed by NSCCL – the NSE Clearing Corporation Ltd. This ensures your stocks are safe.

The NSCCL maintains a detailed risk management system. This system constantly monitors and prevents any market failures. This system ensures that every trading member’s obligations are taken care of.

How Does The SLBM Process Work?

You sign up for SLBM. On an every-day basis, a dealer will inform you if there is an opportunity available to lend some of the stocks in your portfolio. The stocks that can be given on loan or borrowed under SLBM are updated daily on the NSE page here.

The interest rate differs for each stock, the length of the borrowing period as well as the market conditions. Once you hear all the details, you need to agree to lend the stocks. That’s it, you’re done.

The misconception about SLBM taxation

A lot of stock traders often feel that they may attract short-term Capital Gains tax if they start the lending process in the first 1 year of buying the stocks. That is just a myth.

Once you have started lending your stock, the interest you earn is accountable as income from other sources or as income from a lending business. There is no Capital Gains tax involved in this whole transaction. The stocks are not considered to have been sold. So there’s no question of a ‘capital gain’ here.

Are there any charges involved?

We, at Kotak Securities, charge up to 15% of the lending fees or 0.10% per share whichever is higher. Additionally, GST will be charged.