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Stock lending, also referred to as securities lending or fully paid lending, is the way that investors can make money by lending out their stocks instead of selling them. While this sounds complicated, it’s easier than it sounds. It’s also just one of many trading activities that investors use to earn income.
What is Stock Lending?
Stock lending could work in a few different ways. That said, essentially, stock lending works by you lending securities in return for a fee. If your stock goes up, you also earn that income from your stock. The length of time that you temporarily transfer the title of the security is up to you. You can also choose to sell it at any time.
That said, most people choose to stock lend in order to earn some income while they’re waiting for the price of their security to increase.
Who Organizes Stock Lending
With securities lending, the process isn’t usually facilitated by individual investors. Brokers and dealers normally conduct this process. They create a contract and make sure that a lending agreement is completed in order to make sure that the transaction is finalized. It includes the length of the securities lending agreement, the interest rates, and any fees and collateral included in the transaction.
Collateral Required for Stock Lending
When you’re borrowing stock, the collateral required to borrow the stock is based on the market value of the security being borrowed. That said, it’s normally 100% of the securities market value that is required. However, the minimum initial collateral tends to be 102%, as well as any accrued interest. There are also lending fees, and sometimes monthly fees, that are included as well.
Reasons Investors Borrow Stocks
You may be wondering why some people are choosing to borrow securities. Well, there are actually quite a few different reasons. Let’s take a look at some of what these reasons are.
- Collateral: This is the most common reason for borrowing securities. Firms and businesses can be required to put up securities in order to borrow money or just provide day-to-day business. If they don’t have the securities required, they often just borrow them.
- Cover Deficits: When firms and businesses are required to hold a certain number of securities, but they don’t quite meet the requirements, they can borrow them. This is often temporary until it’s possible to acquire the securities needed.
- Participate in Corporate Decisions: In order to participate in corporate decisions, you have to be a shareholder. Some, instead of purchasing the shares, borrow them for a short period for voting rights.
The reasons we’ve already discussed are fairly straightforward; however, some are more complex. These are strategies that investors use to earn money on their investments. They use the stocks as a way of earning lending income while they’re borrowing and selling when the price is high.
Fully Paid Stock Lending
With stock lending, the process used for lending is decided by which brokerage firm you’re using. One of these processes is called fully paid stock lending. It’s up to you whether you want to loan out your whole portfolio, including all the securities, or just individual stocks. From there, other financial institutions and brokerages will be notified of your intent to take out a loan, and the process can start there.
If your stocks are getting borrowed, the lender will sell your shares at the current price and then buy them back later to give back to you. Ideally, the borrower will purchase the stocks at a lower price and earn an income. However, that’s not always the case.
Sometimes, the borrower pays a higher price to buy the securities back and still gives you the stocks. In this case, they’d lose money. This process is often referred to as shorting a stock, but it doesn’t always work. That said, though, either way, the borrower is still supposed to return your shares.
Stock Lending Requirements
When it comes to stock lending, many of the requirements that you need to meet are dictated by the bank or broker that you’re dealing with. For most larger financial institutions, a minimum lending amount of $50,000 to $100,000 is required. That said, other brokers like Wealthsimple have no minimum lending requirements and no account minimums.
When it comes to lending stocks, certain securities aren’t eligible. These include:
- Fractional shares
- Securities that don’t have high demand
- Securities that aren’t earning accretive
You can also lend out different kinds of securities. It’s less common to lend mutual funds and ETFs.
Stock Lending Rates
With stock lending rates, the amounts vary. It’s also based on the brokers you’re dealing with as well as which specific securities you’re lending out.
Stock Lending Program
In Canada, there are many ways to participate in securities lending. One of these is by participating in the Securities Lending Program through the Bank of Canada. With this program, instead of purchasing government securities, they can be borrowed. Like with other securities from the government, the process is done with an auction.
The type of auction that the Stock Lending Program uses is a multiple-rate competitive auction. Once an auction is listed, they provide the date, amount, minimum bid rate, as well as any other relevant information. However, no matter which security you borrow, the term of maturity is one business day.
Pros and Cons of Stock Lending
While stock lending isn’t as common as purchasing and selling securities, it is slowly becoming more popular. That said, like with anything, there are positives and negatives to the process. Let’s take a look at some of these for stock lending.
Pros
The main reason that investors choose to be stock lenders is to gain some additional income. Depending on your investment, you can also turn a dormant investment into an investment that starts earning income again. It can also add liquidity to the short-seller market.
Cons
Unfortunately, when it comes to stock lending, there are more cons than positives for stock owners. However, that doesn’t mean that you shouldn’t stock lend. You should just be careful. Let’s take a look at these cons.
- Increased risk of default from the borrower
- You may need to qualify to participate
- Taxed at marginal rates on payments instead of how you would be taxed on dividend payments
These are also many of the reasons why securities lending is facilitated by brokers and dealers, not individual investors. This provides a little more security and helps to mitigate these risks. That said, there are risks when it comes to investing in general so you do have to make calculated decisions. It’s also a reason that other investors choose not to lend securities.
Risks of Stock Lending
When it comes to stock lending, there are plenty of different risks to consider. This is why investors don’t use stock lending as a long-term solution. It’s often just used on a short-term basis to earn some extra income.
With the stock market, stock prices vary all the time. This is why using stocks as cash collateral for a loan is a short-term solution. If the stock starts to lose value, the collateral is then insufficient and unable to cover the loan amount. In a case like this, it’s possible that the borrower defaults on the loan and is unable to pay back the full amount of the loan. In some cases, the shares can drop to a value of zero, and the loan can go unpaid.
What You Can Make From Stock Lending
The amount that you can earn from stock lending depends on how much stock you’re lending out and what the cost of the stock is. It’s also based on supply and demand. This means the more popular stock that you have, the more that you can earn. You also have to factor in the split with the broker you’re using to lend stocks. That said, though, the split is usually 50/50.
While a 50/50 may not seem ideal, you don’t have to do anything when it comes to stock lending. This is all done by the broker or dealer you’re dealing with. All you need to do is own the securities. Let’s take a look at an example of what you can earn.
For example, let’s say you own 250 shares of a stock that is currently selling for $28 per share. The value of that is $7,000. If your stocks continue to do well and you make returns of 10%, the total earned is $700. If you split that 50/50, the amount you earned is $350. This is pretty good for passive income. You’re letting your money earn more money without having to invest anything else.
Is Stock Lending Safe?
As we’ve mentioned, you do have to be careful when it comes to stock lending. In the short term, the risks can be low. In the long term, though, the risks can be very high. This is because the securities market can be very volatile since the market conditions are always changing.
You can lose money on stocks just as quickly as you earned it. This is often why those you lend securities do so on stocks that aren’t at their peak. They can earn more money this way.
When borrowed securities are used as collateral, they can easily drop and be unable to cover the amount of the loan. This can result in a default for the lender, and they can lose money. This is just a risk, though, often, the amounts are paid back. This is just something to consider.
Is it Worth it?
Whether or not stock lending is worth it is based on your situation. The more borrowed shares you have lent out and the more popular the stock is, the more income you could earn. Plus, the stock still pays dividends (typically monthly) if it’s still earning, even while you have it loaned out.
You do have to consider, though, that the Canadian Investor Protection Fund only protects your funds if you’re investing with a registered brokerage in Canada. They actually cover up to $1 million in investments.
In the event that a stock you lend out is unable to be paid back and you lose your funds, or the investor who borrowed your funds is unable to afford the funds to pay it back, you could lose your entire investment. While this risk is small, it still exists, so you have to decide whether or not that chance is worth it to you.
Final Thoughts
Stock sharing is just one way that investors and borrowers can earn money with stocks. However, just like with any kind of investing, there is no guarantee of your return. Since stock lending requires working with a broker or dealer, you are able to get some professional advice on the best way to stock lend, as well as how to reduce your risk and tax implications.
As a lender, you can earn some decent passive income by lending out your stocks. As a borrower, you can also earn, depending on which strategy you choose as well as which stock you borrow. That said, you do have to be prepared to lose a little bit. While you may earn, you will likely still lose a little.
While it’s common to lend out stock when you own a lot of it, you can still lend it out if you just own a little. However, you do have to be careful which lender that you use. Most lenders just have a minimum lending requirement, but there are a select few that don’t. You must consider all of these options, though, before you start lending. Just like with investing in stocks, research is key when it comes to earning money with stock lending.
