Everything about promoter pledging that you should know

The Reserve Bank of India (RBI) in its Financial Stability Report dated June 27, 2019, expressed its concern over the high level of promoter pledging. The report argued that a high level of promoter pledging indicates the poor financial health of a company and probably a situation that a company is unable to raise funding from other sources.

In the past, many stocks such as Zee Group, Apollo Hospitals, and Reliance ADAG group have tumbled due to promoter pledging.

What is Promoter Pledging? Why do Promoters go for the Pledging of shares? How does it impact share prices? Read on and find below.

What is Promoter Pledging?

If you have ever approached a bank intending to obtain a loan, the bank must have asked you to offer something as collateral. The collateral could be in the form of gold, property, shares, etc.

Now think of a promoter of a listed company who wishes to expand his business, fund new ventures, or fulfill his personal goals approaches a bank for a loan. The bank can ask the Promoter to offer his equity shareholding in the company as collateral. This is what is meant by Promoter Pledging. 
Stated, "Promoter Pledging refers to a situation where the promoter pledges some or all of his shares with the lenders to obtain loans." 

How does Promoter Pledging work?

The bank usually pledges the share at a price below the market price of the share. For example, if the share is trading at Rs 10 in the market, the bank will extend a loan at Rs 5 per share. The margin between the market price and the loan amount is kept as security.

This means that as soon as the market price of the share falls, the banks will call for additional security since the value of the collateral has shrunk. The promoters will pay for the shortfall either by pledging additional shares or by spending more cash. This is known as the Margin Call.
If the promoters fail to address the margin call, the bank can sell the pledged shares in the market to maintain the margin.


Why is it risky for you?

Promoter Pledging is observed in a company where promoters have high equity shareholding. Thus, Pledging is the easiest way for promoters to raise funds.

Promoter Pledging is of no risk for the investors as long as the market price of the share is rising. Some amount of promoter pledging is always acceptable, but in a situation where stocks have high pledged promoter holding, Pledging can create havoc since if the price of the share falls considerably, the lenders will resort to the selling of pledged shares to maintain the margin. The excess supply created due to invoking will further reduce the share prices, thereby leading to huge losses.

Therefore, as an investor, you need to keep an eye on promoter pledging since it can negatively affect your returns in periods of high volatility.

Read More : https://blog.finology.in/investing/Promoter-Pledging

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