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Pledging of shares by promoters: How it matters
In India, promoters are the majority shareholder group that manages the day-to-day affairs of a company. When they need money, very often, promoters of listed companies pledge all or some of their shares with lenders. It means that these shares are offered as collateral to banks in exchange for loans. This is one of the many sources of borrowing money, especially in a volatile market with tight liquidity conditions.
Here are few things to know about the implications of pledging of promoter shares:
Pledging of shares is common in companies where promoter holding is high. While pledging shares, ownership is retained by promoters. In a rising interest rate scenario, promoters often use shares owned by them as collateral for loans. If the majority owner in your company has pledged a sizeable chunk of his or her equity, it could trigger a volatile price movement in a falling market.
Shares of companies with high pledging of promoter holding tend to witness volatility. The Reserve Bank of India, in its latest Financial Stability report, flagged a concern over pledged shares. “Pledging of shares by promoters could pose as a concern in both, falling or rising market scenarios, when large scale pledging of promoter equity could pose concerns for retail investors’ wealth,” the RBI report said. As a result, investors need to look at pledging of shares by promoters before buying stocks.
Higher the pledging, greater could be the risk of volatility in the company’s share price. This is because, as share prices fall, the overall value of the pledged collateral falls. This would put pressure on the promoter to produce more assets as collateral. Sometimes, the lender may also be forced to sell some of the shares to ensure that the loan does not turn into a bad loan. If the promoter is unable to meet obligations of borrowing, the ownership of shares is transferred to the lender, who may then sell it to recover loans.
In India, out of the over 5000 listed companies, promoters of 4274 companies had pledged all or some of their shares, according to an analysis by Securities and Exchange Board of India. This was quoted in the recent RBI Financial Stability report. Of these, promoters of 286 companies had pledged more than 50% of their shareholding. Nearly 90% of these companies belong to the small-cap category.
Pledging of promoter shares witnessed its highest quarterly jump in three years in June 2013 quarter. During an economic slowdown and rising interest rates, banks could put strict conditions on borrowing.
Risk is calculated on the basis of the amount of pledged shares as a percentage of the total shareholding. When the shares pledged exceed 50% of the total shares of the company, the company falls in the high risk category. 48 companies belonged to this category, according to the RBI report. As many as 154 companies fell into the medium risk category with pledging of 25-50% of promoter shares.