A Beginner’s Guide to Securities Lending and Borrowing
Posted On June 11, 2022
(Last Updated On: June 11, 2022)
What is Securities Lending and Borrowing? The SLB (Securities Lending and Borrowing) is the temporary lending of securities by a lender to a borrower of securities for a certain period of time and for a set charge. The SLB mechanism is widely popular across the world because it offers liquidity in the equity market, which improves market efficiency.
The owner of shares or bonds temporarily transfers them to a borrower in the form of securities lending. In exchange, the borrower gives the lender other shares, bonds, or cash as security and pays a borrowing charge.
The owner of shares or bonds temporarily transfers them to a borrower in the form of securities lending. In exchange, the borrower gives the lender other shares, bonds, or cash as security and pays a borrowing charge. As a result, securities lending may be utilized to gradually boost fund returns for investors. Lenders are subject to several risks in practically every securities lending transaction, including counterparty default risk, collateral reinvestment risk, market risk, liquidity risk, operational risk, and legal risk.
Securities lending may be a terrific source of alpha and a method to profit from your portfolio’s hidden worth. The amount of money you make through lending is determined by the availability of your stocks. The ‘generic collateral’ equities, which are more readily available, yield lesser returns, up to 0.5 percent (50 bps).
Securities lending and borrowing is an OTC (over-the-counter) commodity in most jurisdictions, where custodians allow borrowing and lending transactions between institutions. SLB, on the other hand, is an exchange-traded commodity.
In fact, Stock lending and borrowing (SLB) is a method in which traders borrow shares they don’t already own or lend equities they don’t intend to sell right away. SLB transactions, like loans, take place at a rate of interest and for a period of time determined by the two parties involved.
The loan will be regulated by a “Securities Lending Agreement,” which requires the borrower to furnish the lender with collateral equal to or greater than the loaned securities plus an agreed-upon margin, in the form of cash or non-cash securities.
Investors who have certain stocks in their Demat account and do not plan to sell them anytime soon can use the SLB segment to lend for all of them for a set fee and a set duration (determined by the contract entered into), whereas traders looking for short-term opportunities can borrow the shares and potentially profit from price movement in the stock.
Securities Lending and Borrowing (SLB) Characteristics
Short selling, in which an investor borrows securities to sell them quickly, relies heavily on securities lending. By selling the security and then purchasing it again at a cheaper price, the borrower intends to profit.
1) Transactions in the SLB section are insured by Clearing Corporations, and hence do not include any counter-party risk.
2) As of August 20, 2018, the NSE SLB platform offers over 370 equities (this list is updated by NSE on a monthly basis).
3) Contracts with durations ranging from one month to twelve months are available.
4) Turnover fees from the STT and SEBI are not applicable.
Lenders’ Advantages
1) Lenders can supplement their revenue from inactive portfolios by charging a charge to lend the stock, which varies depending on demand and time value.
2) A lender’s ability to lend a certain amount of money is unrestricted.
3) Lenders are entitled to any corporate actions, such as dividends and bonuses, that occur throughout the lending term.
4) There is no counter-party risk since the Clearing Corporations guarantee all transactions.
5) Transactions in the SLB section shall not be recognized as transfers, according to Income Tax Circular No. 2/2008, issued February 22, 2008, and Section 47(xv) of the Act. As a result, Capital Gains Tax has no further implications.
Borrowers’ Advantages
1) Borrowers can engage in short sales of securities that are not available in the derivatives market (once the borrowing is done from the SLB segment).
2) In the Cash category, SLB allows borrowers to pay their obligations in the event of a delivery deficit and avoid an auction (seller shortage).
3) If there is a price differential between the Cash and Derivatives markets, SLB provides borrowers with an arbitrage opportunity.
4) Under the derivatives section, SLB allows borrowers to pay obligations arising from the physical settlement.
SLB is therefore a smart option for investors to supplement their income by leasing their idle assets for a charge and for a certain period of time. Traders, on the other hand, might borrow stocks in order to take advantage of arbitrage opportunities or satisfy their stock exchange obligations.
The platform has various protections in place, including a dependable settlement method, according to market regulator Sebi. Unlike many other countries, SLB is an exchange-traded asset, and it is settled by clearing firms, so there is no counterparty risk.
Investors should preferably lend out their assets in order to earn a higher return, as every cent counts. While yields are a product of demand, we’ve witnessed good loan fee levels in numerous equities over the last 18-24 months.
