A share loan in Nepal is a loan from the bank secured by the value of your stock portfolio.
The loan can be used to diversify your investments and earn a higher return. It can also be used to fund your expenses.
With a share loan, you’re only required to pledge the shares with the bank, that is to say, the shares sit in your Demat account and not with the bank, although they’re locked. It means you’re eligible for all dividends and right shares for the shares that you hold.
Also known as a loan against shares, it is a tool that can both maximise your investment return or magnify your losses.
How does a loan against share work?
With a loan against shares in Nepal, generally, you can borrow up to 70% of the stock value with ordinary shares and 50% with promoter shares. For example, if you had 10,00,000 worth of ordinary shares of commercial banks, you can borrow up to a maximum of 7,00,000 (70%).
Note that banks will use the lower of last trading price of share or average of 120 days price of the share in their calculations.
Then once your loan is approved, you can draw down the required funds to purchase more shares.
You can keep the loan facility without using any funds, and you won’t be charged interest on the unused loan amount.
Most banks have a minimum loan amount for this type of loan, this is usually around 5 Lakh but can be higher depending on the bank.
Under the current share loan provision in Nepal, the maximum an individual investor can borrow is 12 crores with a cap of 4 crores with a single bank.
How does a share loan affect your returns?
Let’s look at an example of how a share loan works to increase your returns:
|Without A Loan Against Shares||With A Loan Against Shares|
|Margin loan (50%)||0||500,000|
|Number of Shares||1000||1,500|
|Scenario 1: The value of the stock goes up by 50% after one year|
|Share Sale Proceeds||15,00,000||22,50,000|
|Interest On Margin Loan @ 10% p.a.||0||50,000|
|Return On Investment||50%||70%|
As you can see with a 50% margin loan, your net return on investment after interest payment is 70%.
Note that the higher the leverage, the greater the returns. However, this brings us to the other side of the equation, what happens if the value of the stocks goes down.
|Scenario 2: The value of the stock goes down by 50% after one year||Without A Loan Against Shares||With A Loan Against Shares|
|Share Sale Proceeds||2,50,000||7,50,000|
|Gross Gains/(Loss)||– 2,50,000||– 7,50,000|
|Interest On Margin Loan @ 10% p.a.||0||50,000|
|Net Profit/(Loss)||– 2,50,000||– 8,00,000|
|Return On Investment||– 50%||– 80%|
Similar to how you were able to gain more by using leverage in the case of the value of your stock decreasing, your losses are significantly magnified.
Note that in the event that stock prices decrease and the loan amount exceeds 70%, banks issue what’s known as a margin call.
A look at the historical performance of the NEPSE index is really helpful here.
What is a margin call?
Banks want to ensure that your loan amount never exceeds the maximum they’re willing to lend, i.e. 70% of your portfolio.
If the shares you’re using as collateral has decreased in value which causes your loan to portfolio ratio to exceed 70%, a margin call is triggered.
If you reach a margin call, the bank will ask you to deposit extra cash or sell some of your shares to bring the loan amount to the original 70%.
A margin call often forces investors to sell at the worst possible time if they’re not prepared.
A margin call example
Ram Bahadur has a stock portfolio of 10 Lakhs, and he decides to borrow the maximum 70%, which is 7 Lakh. He uses it to buy 700 shares of NIC Asia Bank at Nrs. 1,000.
Now later, if NIC Asia’s share price falls by 10% to Nrs. 900, then Ram’s shares of NIC Asia are now only worth Nrs 6,30,000, which means he now has to either deposit Nrs 70,000 or sell some of his NIC shares to bring his LVR down to 70% of his stock portfolio.
How to avoid getting a margin call?
The best way to avoid getting a margin call is to borrow less than the maximum LVR allowed.
The less you borrow, the more the market needs to fall before you would reach a margin call.
So, for example, if the maximum LVR is 70%, then you can choose to only borrow up to say 50% to reduce your risk of getting a margin call.
|LVR||Market fall before a margin call is triggered|
Acceptable securities for a share loan in Nepal
Each bank has its own list of acceptable securities. So, please head over to their website or ask for a list of their acceptable securities directly.
Generally speaking, most banks will lend the full 70% against listed shares of companies that are categorized under A and 60% for B categories as categorised by the Nepal Stock Exchange Ltd.
The following companies are generally considered to be acceptable securities for a loan against shares:
- A Class Commercial Banks,
- B Class National Level Development Banks,
- C class National Level Finance Companies,
- D class National Level Microfinance,
- Life & Nonlife Insurance Companies,
- Others (Bottlers Nepal Ltd. (Balaju), Bottlers Nepal Ltd. (Terai), Unilever Nepal Ltd., Nepal Doorsanchar Co. Ltd., Citizen Investment Trust, Nepal Reinsurance Company Limited, Shivam Cement Limited)
Only some banks will not accept the following as acceptable securities:
- Promoter shares of all types
- Mutual Funds
- Hydropower Companies
- Shares of Investment Companies. Eg: NRN Infrastructure and Development Limited.
- Shares of companies under merger whose trading is halted for the time being.
- Stocks with a market value less than their par value
- Shares of companies with negative networth and also shares restricted to be considered by NRB Directive for margin lending.
Note that a lot of other banks do accept promoter shares as acceptable shares albeit with a 50% maximum lending limit such as Machhapuchre Bank, Siddhartha Bank, Prime Commercial Bank.
Tips for managing your share loan in Nepal
Managing your share loan is all about risk management.
- Understand your strategy and stick to it. Before you invest, have a clear idea of how much you want to invest, your investment horizon, what stocks you want to buy, your entry/exit strategy and what you will do in case of a margin call. Having a disciplined approach can help you to make better investment decisions.
- Always borrow less than the maximum. Go for lower leverage than the max you’re able to borrow, as this will give you a buffer to protect yourself against being margin called by the banks.
- Diversify. You can reduce the risk from the fluctuations of individual stocks by spreading your investment across several stocks in different industries. A fall in one stock may be offset by a rise in another stock.
- Research your stock purchases. This is especially true for stocks purchased with margin loans. Reserve buying on margin for only your highest conviction stock purchases.
- Stagger your purchases. You don’t have to make all your purchases on the same day. Stagger your stock purchases over a period of time. Also known as ‘dollar-cost averaging, it helps you reduce the risk of timing the market by spreading your investments over a more extended period.
What do you think? Is a share loan in Nepal a good idea?Let me in the comments.