What is stock lending?
Stock lending is when you allow others to borrow stocks you own in return for a fee, typically paid monthly. You are “renting out” your stocks so that others can use them to perform trading activities (see below for some examples of these activities). If you’re not planning on selling a stock anytime soon, it’s an easy way to earn income while you wait for the stock’s value to appreciate.
Why would someone borrow a stock?
Lots of reasons! Some are more complicated than others.
To use as collateral. Firms often need to pledge certain securities to banks in order to do business or to secure a loan. If they don’t own those securities, they can borrow them.
To cover deficits or failed deliveries. Firms can also be required to hold a certain number of securities. Sometimes, those firms violate regulations by lending or transferring some of the segregated securities, or there’s a delay in getting securities they were expecting. In those cases, firms will often borrow securities to meet their obligations.
To short the stock. This is the one that gets the most attention. If an investor thinks the value of a particular stock will go down, they can borrow it, sell it, and then buy it back at what they hope will be a lower price, pocketing the difference.
To facilitate tight two-way pricing on stocks and ETFs. Remember how we said some reasons were more complicated? Here it comes: tight two-way pricing happens when the price buyers are willing to pay for a stock is similar to what sellers are willing to accept for it. The difference between the two is called the spread, and if the spread is wide, it’s harder to trade securities at a fair price. Some brokerages, called market makers, try to keep the buy and sell prices close. In some cases, if they are officially assigned to a stock by the stock exchange as the market maker, they are obliged to maintain the stock at a specific spread. To do so, they often provide their own buy and sell orders, propping up whichever side of the exchange needs it more. If they need to sell the stock that they offered up to keep the spread, they have to borrow that stock to complete the order.
To exert influence. Firms may borrow shares in order to participate in corporate actions, like voting rights, with the goal of influencing management decisions in order to protect their inherent long position.
How does fully paid stock lending work?
Different brokerages use different systems. You can often choose to lend your whole portfolio or just individual stocks. Once you activate your account for lending, other financial institutions can see that your stocks are available and they’ll borrow them based on demand.
For example, let’s say a borrower wants to short a stock that you own for one of the reasons listed above. They borrow the stock from a broker and sell at its current price, then buy the same number of shares back later, ideally (for them) when it costs less. If the price drops, they pocket the difference and return your stock. If the price goes up, they are required to buy it at the higher price and return your stock. No matter what happens, they’re on the hook for returning your shares to you.
What are the benefits of securities lending?
For shareholders, stock lending offers a relatively low-risk way to earn extra returns on the stocks you already own. You maintain ownership of your stocks the whole time. If loaned stocks go up in value, those returns are still yours. If you decide to sell your stocks while they’re loaned out, you can. And if you ever decide you want your stock back and opt out of lending, you can do that, too.
For borrowers, stock lending provides a way to use or trade on a stock without buying it, which has the advantages listed above.
How much money can I make with securities lending?
As in most of finance, supply and demand determine value. So if you have a stock that a lot of people want to borrow, you’ll earn more for loaning it.
For example, say you own 300 shares of a high-demand stock trading at $20. That gives you a notional value of $6,000. Stock lending providers often split the earnings 50/50 with clients, so if lending returns are 8%, assuming traders were actively borrowing that particular stock all year (and it traded at $20 the whole time), you could receive 4% of $6,000, or $240. And all you had to do was…nothing.
Which stocks qualify for fully paid stock lending?
Many stocks qualify, but short sellers tend to be most interested in the ones that are inclined to fluctuate. Think: GameStop, Rivian, AMC, BlackBerry, etc. You certainly wouldn’t want to select your portfolio based on what short sellers want. One good reason is that the short sellers are predicting that the stock’s price will fall, and you probably don’t want a portfolio filled with assets people think will fall. But if you own a bunch of that type of stock, you have more potential to lend than someone who has only relatively stable mutual funds or a stock like Apple, whose strong historical performance means not nearly as many people are interested in borrowing it.
Can I make any money lending something like an index fund or ETF?
It’s possible but unlikely. Index funds and other relatively stable stocks are eligible for lending, but people may not be interested in borrowing them.
Who can participate in stock lending?
That depends on your lending institution. Most banks require potential lenders to have $50,000 – $100,000 invested to be eligible.
Are there risks to stock lending?
When you invest with a registered brokerage in Canada, up to $1 million of your investments across eligible account types are protected by something called the Canadian Investor Protection Fund (CIPF). (It’s kind of like the CDIC coverage you get with deposits at financial institutions.)
With stock lending, there is a small risk that a borrower could go bankrupt — maybe the asset they borrow from you increases so much in price that they can’t afford to buy it back and return it to you. If that were to happen, the CIPF does not provide any coverage.
However, firms have devised an alternative form of protection: traders borrowing securities are required to put up collateral worth at least 100% of the value of the stocks they borrow. That way, even if the borrower goes bankrupt, lenders have some protection.
Another potential drawback relates to voting rights. While your stocks are on loan, you’ll lose the power to vote at annual meetings, on corporate actions, or for board seats. This mostly applies to people with a large amount of stock in a particular company who are normally involved in the way it is run. If that’s you, you might want to think twice about lending those stocks.
Does stock lending encourage short selling?
Short selling is only one of many reasons people borrow securities (see above), but it is by far the best known, and its effects are the subject of constant debate. While short selling may apply downward pressure on prices, that is the case with any kind of selling. It’s a fundamental part of supply and demand.
Empirical studies have found that short selling does not have a significant effect on stock prices. During the 2008 financial crisis, short selling was blamed for driving the market crash — and temporarily banned in order to stop the slide. A few years later, the U.S. Federal Reserve looked at stock prices during that ban and others, finding that “the bans did little to slow the decline in the prices of financial stocks.” Another short selling experiment, published in 2010, found similar results.
What if I want my stocks back while they’re lent out?
Because you own the stock throughout the loan, you can always opt out of lending an individual stock or the whole stock-lending program. If you’re interested in selling your stocks, you don’t even have to recall them or opt out of the program. Just sell your loaned stock as you would any other security.
