Imagine what would you do if you are in desperate need of money either for your personal reasons or for your company, but you know that you have zero credit in your account?
You will pledge because that’s what happens in the world of investment.
What is the pledging of shares?
Pledging is one of the means of borrowing funds to satisfy the varied corporate capital demands such as the establishment of a new company, financing of other companies, for growth and more. Simply put, the guarantee of shares is established by using the securities as collateral to take a loan from the bank. If the company owners use the funding for day-to-day corporate practices or for private purposes, they contribute their shares to the bank to allocate funds. Pledging of shares is one of the many different sources of borrowing or raising money. This condition particularly occurs when the market is either slow or volatile. In that case, if the promoters go with the option of pledging their shares, it means that there is no option left for them in the market to make some money. It happens after the downturn of the economy since equity is often known as collateral, it can also be used as security for taking banks’ loans. If a promoter is using this technique to expand his business then it considered good, but if it provides an easy escape route to the promoter if the funds are raised then it is considered wrong.
What are the dangers of pledging?
It is one of the sources to secure funds from the bank to buy the shares, but there are still certain uncertainties that should not be underestimated. As stock values rise, there are no issues in the bull market because consumers are positive about it. Nonetheless, during the bear market, the major problem arises. The share rates are not stable and fluctuate. So, the biggest challenge for the promoters is during the bear market is to sustain the value of securities. It is very clear that the net worth of the securities would, therefore, drop if the stock values drop continuously. The promoters would need to negotiate extra cash or commit more shares in order to preserve the gap in interest. In the worst-case scenario, the investor can sell the securities provided to recover their capital if the promoter fails to make up for the promised amount.
Typically speaking, the stock price may drop dramatically on the news that loans sell open market shares sold by the promoters are pledged as it will lead to an increased reduction in collateral due to public hysteria. The purchase of the pledged stock by the borrowers will even alter the company’s investment profile. That might affect on promoters’ voting strength, as they now have fewer shares and their ability to make strategic decisions. In fact, if the stock price begins to collapse, share obligations will trigger a catastrophe. The promoters must continually pledge to more securities in order to cover the gap in the collateral value.
Can banks sell your shares in the open market?
Yes, if the promoters cannot provide enough cash or securities to cover the gap, the banks will have the option to sell the stock. However, in any case, if the promoters are willing to supply additional cash or share pledge is removed, it will produce a favorable outlook towards the business between the owners.
Additionally, investors note that the number of pledged shares will not change with hundreds and billions of dollars. Because according to the equation of supply and demand the prices go low falls as supply increases. If the bank then wants to sell many of its shares on the stock market, it would cause a tremendous amount of supply and a sharp price decrease.
Can you check for pledging?
Yes, there are many websites that are offering their services to the clients if they want to check for pledging. Also checking for pledging is the most significant part of investing especially for a retail investor. Because no one would like to take loans with so many restrictions and very low margin. The pledged percentages of shares can be checked on websites like screener.in or money control.
The pledging of shares is generally seen in the businesses in which the promoters’ shareholding is high. As a precondition, the promoters should avoid the pledging of shares above or more than fifty percent. It should be kept in mind that the companies involved in the high rates of pledging should be completely ignored, especially if you are a beginner investor. The truth is that the pledging of stocks is a symbol of weak cash flow, low creditworthiness, heavy debt and inability to fulfill the short-term necessities. If there is a decrease in the pledging of shares it is a positive indicator for the investors. However, if there is a high increase in the pledging of stocks then it can be very risky for the promoters as well as the stakeholders. Moreover, if there is no significant decrease in this business eating moth it can also affect many high running companies and businesses. If the business has a growing cash flow in its sales, and positive hopes for the future, so it is not of great concern to them. The pledging of shares also allows the organization to develop or pursue new ventures that contribute to improved profits in the future.
It should also be kept in mind that if you look around your manipulation is everywhere and pledging of the stock is manipulation in the world of investment. If you are keen enough you would never invest in something that is risky or that might cause loss to your business. If you seek help from financial analysts or advisors, they would never recommend you invest in a company that has low cash flow or is in heavy debt. So, it is your duty as in investor to look if the company you are investing in has a bad reputation or not because ultimately it can affect you and your future life goals, whether it be buying a car or saving for retirement.