SLBM: Stock Lending and Borrowing Mechanism

If you have stocks lying simply idle in your respective Demat account, then SLBM is for you to make some extra bucks. You should seriously consider taking advantage of the trading opportunities, such as when there are discounts on futures. However, you may miss the golden chance if you do not have the required stocks to make the necessary trades. With a proper understanding of SLBM, one can make use of this immensely profitable way to gain the best.

SLBM stands for Stock lending and borrowing mechanism. It is a legally mandated method or mechanism to lend and borrow the securities one holds. The mechanism and its regulations came into existence, with the SEBI formulating them in May 1997. The procedures saw further modification in November, 2012. All the different market participants, including the retail investors, have the requisite permission to lend and borrow stocks or securities. The only exception here is for the Qualified Foreign Investors. Those allowed to carry out stock lending and borrowing only through authorized intermediaries. 

The NSE (National Stock Exchange) Clearing or NCL, in short, and the Limited BSE (Bombay Stock Exchange) Clearing corporation are the two examples. These two organizations have authorization from the Securities and Exchange Board of India (SEBI) in India. The NCL holds much priority for those looking to carry out transactions in bulk. The practice is not a very commonly known one, though.

The stock lending and borrowing mechanism find a place in the investing strategies mostly among the school of experienced traders. They generally are not much averse to opting for additional risks from which the casual investor refrains. Stock borrowing and lending can be useful to most investors. According to their investor profiles, they should look to use the strategy as often as they can. The stocks are available for lending and borrowing in the same way as other assets. 

One can lend as well as borrow those stocks trading as derivatives in futures and options in the share markets. The mechanism involves two kinds of participants, a lender, and a borrower. So, before taking a deep look at the mechanism itself and the procedures involved, let us develop an understanding of the lender and borrower. Also, one should know what will be at stake and the benefits of whether he is either a lender or a borrower.

Who are the Lenders?

The stock lending and borrowing mechanism provide handsome returns on the assets otherwise kept as such in an investor’s portfolio. There may be investors who have the shares of a particular business entity and plan to have them for a long time. They have a pretty good amount of investments in the market. Having the aim to remain invested for a long time, one can choose to lend the shares on a short-term basis. 

There is the assurance of institutions like NCL, which act as guarantors. So lending the stocks one has in their portfolio will generate additional income as there may be good amounts of profits. It is quite similar to lending your unused property like a piece of house. Keeping it that way will not bring you a penny.  If you rent it to someone, on the contrary, it will bring you monthly returns on a consistent basis. The institutions like an insurance company, mutual funds, HNI, banks, and even retail investors can lend their holdings.

Who are the Borrowers?

The borrowers are generally those who expect the value of stocks to go down in the coming times. A borrower has some of the following few opportunities to exploit and take the profits.

• The arbitrage available in the stock prices between any two exchanges.
• Reverse arbitrage when the futures are available with the discounted sales to stocks. 
• Short selling takes advantage of a decrease in the prices of assets.
• Options which some have prices not matching their eccentric value. We call such a condition an asset as a mispricing. 
• The strategy to hedge, which needs stocks at hand. One can get them using the SLBM.

All the above instances have good potential to earn rewards. Let us take an example: one can borrow and make good profits. Let’s suppose there is a particular company offering the reverse arbitrage opportunity. It may have the prices of its stocks at Rs 290. At the same time, the futures may be available at a price of Rs 282. So, he will buy, let’s say, 2 lots of the company’s futures at the price of Rs. 282. On the day of the expiry date, as the company’s share price arrives at the same level as that of the stocks, he will sell the futures. Further, he will buy the stocks and then give them to the one who lent him. If the lot size is 500 shares, the entire whole transaction will be Rs 500*2*8= Rs 8000.

Steps Involved In SLBM

The following is the  step involved in the stock lending and borrowing mechanism (SLBM):

Step 1: The Lender Places An Order

Lenders begin the process by placing an order for a specified number of stocks. They contact the institution offering the SLB facility and provide details such as the number of stocks to be lent, desired fees, and duration of the loan.

Step 2: A Borrower Expresses His Requirements

To borrow stocks, the borrower contacts the institution and communicates their needs. The details include the desired stocks, the duration, the quantity, and the fees.

Step 3: The Matching Of Fees

The institutions that facilitate SLB match the fees proposed by the lender and borrower.

Step 4: The Lender Provides Margin

Lenders have to give a margin of 25% of the stock quantity. This ensures that the lender doesn’t default after agreeing to terms. The margin is returned to the lender when the shares are transferred from the Demat account to the institution.

Step 5: The Borrower Provides The Margin And Fees

Borrowers have to provide a 125% margin on the stock quantity, which includes the fees as well. Once the borrower has borrowed the stocks, he can sell them while keeping 25% of the margin. Upon performing a transaction, the borrower must provide the whole 125% margin.

Step 6: Getting The Deal Done

Upon completion of the agreement period, the lenders get their stock back into their Demat accounts. Borrowers also receive their margin back.

What about Dividends and Stock splits?

The borrowers have to pay the dividends on the next day of the record date to the exchange. The exchange would then give it to the lenders. When stock splits occur, the borrower SMS has their required stocks, if any. It is noteworthy that the lender doesn’t have the stocks currently stored in the demand account. Still, they enjoy the benefits of any corporate action.

Features of SLBM

The following are the features of SLBM.

1. There is an automated trading platform for matching trades.
2. The maximum period of lending and borrowing is 1 year. 
3. The lenders have the facility of early request placement.
4. The borrowers get the flexibility to make pre-payment of securities while returning them to the lenders.
5. The transaction period is on a monthly basis. There are specified reverse leg settlement dates.

The advantage of SLBM

SLB has the following advantages.

1. From the lender’s perspective, stock lending can bring extra income. The fees of lending serve as the profits.
2. SLBM also provides portfolio diversification. There are numerous securities that have derivatives in the F&O market.
3. The SLB is a very good method that assists in short selling. One can short sell the stocks borrowed using SLBM when there is a possible bearish trend. 
4. The SLBM comes at almost no risk. This is because there is a guarantee of NCL. 
5. Also, It is not mandatory to carry out physical settlement.

What Is The Interest Rate On Stock Lending And Borrowing?

Interest rates on securities lending and borrowing vary from stock to stock. Furthermore, the interest rate depends on the market conditions and the tenure of borrowing. However, according to SEBI, stocks can be borrowed for a maximum of 12 months.

Furthermore, key lenders in SLBM are long-term investors, such as insurance companies and mutual funds. Compared to options and future contracts, stock lending and borrowing schemes are relatively less risky. A number of stocks are available for borrowing on the SLB platform.

Documents Required When Opting For SLBM

When opting for SLBM, you must provide basic documents. Here are the documents you need:

• PAN Card
• Your identity documents, such as your Aadhaar Card, passport, voter ID card, and driving license
• Check with your broker if additional documents are required.

Conclusion

The stock lending and borrowing mechanism is a facility that allows the investors to lend and borrow shares. This is a great method to lend the long-term stocks sitting idle. The SLBM is highly helpful in repairing considerable profits, and that too is a very low risk. Investors can lend or borrow stocks for a fixed amount of duration and at a fixed rate of lending fee. One can use SLB for short selling, exploit the arbitrage available, and hedge against assets. This will certainly help make good profits. So, investors can use the method in multiple ways to make a profit and diversify their portfolios.

Frequently Asked Questions (FAQs)