Securities lending and borrowing aka stock lending and borrowing refer to the method of lending or borrowing shares for a specific period of time at a certain fee. In the Securities Lending & Borrowing Scheme (SLBS) investors and other market participants can come together and borrow or lend shares.
Understanding Securities Lending & Borrowing (SLB)
In securities lending and borrowing, there are two different parties – lenders and borrowers. Under securities lending, the lenders lend the shares that they own but do not intend to sell however, under securities borrowing investors borrow shares to sell that they don’t own.
The term could be rather new but if you’ve been trading in the stock market then you must be familiar with the term ‘short-sellers’ or maybe ‘short-selling’. Short sellers are those borrowers (traders) who short-sell shares (sell borrowed shares) that they do not own. On the other hand, the lenders are those long-term investors who purchased shares for long-term purpose and lying idle in the DEMAT accounts.
To better understand this, let’s illustrate an example:
An investor who is certain that Stock X which is trading Rs. 500 per share will decline in value when the company announces its quarterly earnings report in one week borrowed 200 shares of that company.
After buying the borrower short-sell those 200 shares of the Stock X which he even he didn’t own. A week later, the Stock price of X falls to Rs. 450 after the announcement. The borrower or short-seller decided to close his position. So, he buys back 200 shares of Stock X from the open market price of Rs. 450 per share and returns to the lender.
Investor paid Rs. 1,00,000 to short-sell shares and when he returned he made Rs. 1,00,000 – 90,000 = Rs. 10,000.
Here, he made a profit of Rs. 10,000 from short-selling but if the stock price increased to Rs. 550 then he would’ve lost Rs. 10,000.
Benefits of Securities Lending & Borrowing (SLB)
In securities lending and borrowing scheme (SLBS) where the investors borrow the stocks from lenders in order to make quick profits by selling the security, they don’t own and buying back later at the lowest price.
For traders or borrowers, the SLB is a less risky option compared to the futures and options contracts. With the borrowing shares, the borrowers become temporarily owner of the shares and get the rights of casting votes and other many things.
The transactions of SLB are guaranteed by NSCCL so there is no counterparty risk. Short sellers can take the benefit of short-selling the stocks during the times of market downturn. However, even in temporarily ownership, the borrower is liable to pay any dividend out to the lender.
Hope, this article helped you in a way you expected it to be. Nevertheless, if you have any query regarding securities lending and borrowing then don’t hesitate to mention in the comment section below.