If you invest in stocks for the long-term and want to generate a passive income from your shares idling in your demat account, check the stock lending and borrowing (SLB) mechanism offered by the exchanges.
How it works
To avail this facility, first check whether your stock broker has access to the SLB segment. The brokers need to take separate access to the SLB segment and your broker may or may not have it.
If the broker does have the access, you will need to inform your broker that you would like to lend shares and also share the list of stocks from your portfolio that you wish to lend. As and when there is demand for borrowing of shares that matches your list, your broker will inform you about the lending opportunities.
The demand is generated by short-sellers when they need to short a stock. Short-selling entails selling the stock first (on expectation that the stock price might fall) and buying it later to square-off the position.
But short-sellers cannot sell what they don’t have. Hence, they need to borrow the shares from existing investors and return the shares after squaring off their position. The SLB mechanism allows short-sellers up to 12 months to hold onto their position. But these transactions are typically for few weeks to a month.
How lenders earn
Share lenders get a fee on the stock that is borrowed from them. For instance, a borrower needs 5,000 shares of company A, which are currently trading at ₹100 each (value: ₹5 lakh). Now, a borrower is willing to pay 50 paise for each share in lending fees for borrowing the shares for a month, which works to ₹2,500 on the 5,000 shares.
For the lender, this translates to an annualized yield of 6%. Here is how the calculation works — lending fee of 2,500 divided by 5 lakh worth of shares, works to 0.05%, which multiplied by 12 (annualized for 12 months) comes to 6%.
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The lending fee would typically depend on the borrowing demand for the security. This demand might rise when a share that’s not available in F&O (futures and options) segment is going through a period of volatility; a typical situation short-sellers look to take advantage of.
Rules and requirements
For the lender, the minimum order value per security needs to be ₹1 lakh and for the borrower, the minimum borrowing requirement is that of 500 shares. Brokers charge 15-18% brokerage on lending fee and goods and services tax of 18% is applicable.
The borrower is required to put 125% of the value of shares he or she is borrowing as margin. For example, if the shares are worth ₹5 lakh, the borrower would need to put 125% of value as margin, or ₹6.25 lakh. This margin is also mark-to-market. So, when the prices move against borrower’s position, these unrealized or notional losses are debited from the margin. The borrower needs to ensure that the margin is restored and maintained.
This high margin requirement is also the reason why SLB mechanism is less preferred by short-sellers and bulk of the trading volumes is on the F&O segment, where the margin requirement is 17-25% in most cases. But SLB mechanism offers much wider access to shares. The F&O segment has 182 scrips, while the SLB segment has 800-900 shares.
For the lender, the margin requirement is 25% of the value of the shares being lent. So, in the above example, the lender will be required to keep margin of ₹1.25 lakh in his broking account for lending ₹5 lakh worth of shares, which gets immediately released after the shares move out of the lender’s demat account. Some brokers even ask the lender to transfer the shares on the same day the borrower submits the request; in which case the lender doesn’t need to put up any margin.
Risk of default
The clearing corporations of NSE and BSE—National Securities Clearing Corporation and Indian Clearing Corporation—act as approved intermediaries (AI) and guarantee the settlement on SLB.
The job of the AI is to collect the margin from both lender and the borrower. In case, the borrower defaults on returning the share, the AI will use the margin deposited by the borrower to purchase the shares in auction and return it to the lender.
Conclusion
When a short-seller borrows a stock, it’s because they expect the price to fall. That’s why SLB works best for shares you plan to hold long-term, even if short-term volatility sets in.
If you suddenly want to sell shares that are already lent, things can get tricky. A recall request usually takes a few days, during which prices may move against you. If you want them back immediately, you may have to pay the prevailing lending fee in the market—which could be higher than what you originally charged.
