# Securities Lending Overview: Processes, Pros, and Risks

> **Definition**
>
> Securities lending happens when one investor lends a security, such as a stock or commodity, to another, usually though a broker.

## What Is Securities Lending?

Securities lending involves the temporary transfer of securities, such as stocks or derivatives, to another investor or firm, with collateral provided by the borrower. This process supports short-selling, provides additional income for the lender, and contributes to market liquidity. Key agreements outline terms like loan duration and interest, while the importance of maintaining collateral and understanding potential risks, such as loss of voting rights or borrower default, is essential for participants.

### Key Takeaways

*   Securities lending involves loaning shares or other securities to investors in exchange for collateral.
*   This practice, facilitated mainly by brokerage firms, is essential for short-selling, hedging, and market liquidity.
*   Lenders receive loan fees and can generate additional returns, though they lose certain rights, such as voting.
*   Risks include borrower defaults and complex tax implications on dividends and loan proceeds.
*   Regulatory bodies like the Federal Reserve and the European Central Bank utilize securities lending to maintain market stability.

![Securities Lending: Loaning shares of stock, commodities, derivative contracts, or other securities to other investors or firms.](https://www.investopedia.com/thmb/yVoU8M1DQMdRydFbDGZzWmYHok4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/securitieslending.asp-final-fef00de79d274df48601ebc73a829c8d.png)

*— Investopedia / Ryan Oakley*

## How Securities Lending Operates

Securities lending is generally facilitated between [brokers](https://www.investopedia.com/terms/b/broker.asp) or [dealers](https://www.investopedia.com/terms/d/dealer.asp) and not directly by individual investors. To finalize the transaction, a securities lending agreement or loan agreement must be completed. This sets forth the terms of the loan, including duration, interest rates, lender's fees, and the nature of the collateral.

According to current regulations, borrowers should provide at least 100% of the security's value as collateral. Collateral for securities also depends on its volatility. The minimum initial collateral on securities loans is at least 102% of the market value of the lent securities plus, for debt securities, any accrued interest. In addition, the fees and interest charged on a securities loan will often depend on how difficult it is to locate the securities desired for borrowing. The more scarce the supply of available securities, the higher the cost.

Typical securities lending requires clearing brokers, who facilitate the transaction between the borrowing and lending parties. The borrower pays a fee to the lender for the shares, and this fee is split between the lending party and the clearing agent.

## Advantages and Disadvantages of Securities Lending

Pros

*   Enables short selling
    
*   Helps investors hedge their portfolios
    
*   Allows investors to earn profit from their securities in more ways
    

Cons

*   Stock holders lose voting rights on loaned stock
    
*   Determining tax libaility can be complicated
    
*   Borrowers may default, failing to return the owed security.
    

### Pros

*   **Enables short selling.** Securities lending is important to [short selling](https://www.investopedia.com/terms/s/shortselling.asp), in which an investor borrows securities to immediately sell them. The borrower hopes to profit by selling the security and buying it back later at a lower price. Since ownership has been transferred temporarily to the borrower, the borrower is liable to pay any dividends out to the lender.
*   **Helps investors hedge their portfolios.** Short selling and securities lending in general helps investors hedge their portfolios, limiting potential losses. For example, if you lend a security to a borrower for a fee, you'll retain that fee even if the share's value drops.
*   **Allows investors to earn profit from their securities in more ways.** With many types of securities, investors won't realize a profit until they sell. Lending a security, for a fee, lets the investor earn a return from that security without selling it.

### Cons

*   **Stockholders lose voting rights on loaned stock.** If you own stock, you can vote on important company decisions, such as determining the board of directors. If you loan out a stock, you lose your voting rights, transferring them to the borrower for as long as they hold the shares.
*   **Determining tax liability can be complicated.** When lending shares, it can be complicated to determine who owes tax and what types of tax are owed on things such as dividends, proceeds from the sale of the securities, and fees charged for the loan.
*   **Borrowers may default and fail to return the owed security.** If you lend a security to someone, they may not be able to return it in the future. That would leave you forced to pursue legal action to recover your lost securities or accept the loss.  
    

## What Is Short Selling in Securities Lending?

A [short sale](https://www.investopedia.com/terms/s/shortsale.asp) involves the sale and [buyback](https://www.investopedia.com/terms/b/buyback.asp) of borrowed securities. The aim is to sell high and buy back lower. These transactions occur when the securities borrower believes the price of the securities is about to fall, allowing him to generate a profit based on the difference in the selling and buying prices. Borrowers owe fees to the brokerage, no matter the profit (or loss) from the short sale.

### Securities Lending: Rights and Dividend Implications

In a lending agreement, all rights transfer to the borrower. This includes [voting rights](https://www.investopedia.com/terms/v/votingright.asp), the right to dividends, and the rights to any other distributions. Often, the borrower sends payments equal to the dividends and other returns back to the lender.

## Securities Lending Illustrated: A Practical Example

Imagine an investor thinks a stock price will drop from $100 to $75 soon. The stock is not very volatile and generally trades in defined ranges. To profit from this thesis, the investor borrows 50 shares from a securities firm and sells them for $5,000 (50 shares x $100 current price). 

Assuming the share price drops to $75, the investor will purchase 50 shares for $3,750 (50 shares x $75 price) and return them to the securities firm. In this case, the profit on this short-sale transaction is $1,250 ($5,000 - $3,750). However, short sales aren't always successful. If shares rise instead of falling, the investor must buy them back at a higher price, resulting in a loss.

## Federal Reserve's Role in Securities Lending

The [United States Federal Reserve](https://www.investopedia.com/federal-reserve-4689790) is involved in securities lending, with some Federal Reserve banks lending both American government and governmental agency bonds to certain bond dealers.

For example, the New York Fed holds auctions each business day during which it allocates securities loans to the best available bidder. The more that a firm is willing to pay as a loan fee, the better that firm's chances of winning the bid and securing the loan. These loans assist the Federal Reserve Open Market Committee in implementing monetary policy by smoothing out the clearing of debt securities.

## How the European Central Bank Engages in Securities Lending

Like the Federal Reserve, the European Central Bank also participates in securities lending. Since 2015, Eurosystem central banks have offered loans for securities purchased under the public sector purchase program, which includes bonds issued by national governments, as well as recognized agencies, international organizations, local and regional governments, and multilateral development banks in the euro area.

The ECB offers securities loans to help keep European markets running smoothly. Under its Expanded Asset Purchase Program, the ECB purchased many securities, reducing the number available on the open market. Securities lending helps increase market liquidity, leading to a more efficient market.

## Recent Controversies in Securities Lending

Recently, securities lending has led to scandals with some brokers involved in the practice. In December 2023, FINRA fined four companies—M1 Finance, Open to the Public Investing, SoFi, and SogoTrade—a total of $2.6 million.

These companies enrolled customers in a securities lending program, allowing them to borrow their customers' securities and lend them out to third parties. FINRA alleged that these companies did not establish proper supervisory systems for these securities lending programs or have any method for determining where it was appropriate for any specific customer to enroll in the program. FINRA also alleged that the companies failed to offer proper compensation for borrowed securities.

## How Can Securities Lending Help the Stock Market?

For a market to be efficient. it must have enough liquidity to meet investor demand. If there are too few shares available for trading, it can lead to larger [bid/ask](https://www.investopedia.com/terms/b/bid-askspread.asp) spreads and make it difficult for investors to complete transactions. Securities lending can increase liquidity by making more shares available for trading.  

## Is Securities Lending Available to Regular Investors?

Yes, many brokeragess make it possible for regular investors to participate in securities lending. Brokerages that offer this service typically pay interest to investors who are willing to lend securities for as long as the securities are loaned out.

## What Are the Risks of Securities Lending?

Securities lending isn't without some risk. For example, it's possible that you won't get paid back after lending out your securities. Many brokerages try to limit this risk by requiring that borrowers have large amounts of collateral before they can borrow securities.

## The Bottom Line

Securities lending allows investors to lend their stocks or other securities, thus enhancing market liquidity and generating additional income. This process plays a pivotal role in trading activities like short selling, hedging, and arbitrage. However, participating investors must be aware of potential risks, including the loss of voting rights and the complexity of tax liabilities. Before engaging in securities lending, consult your brokerage for service details and evaluate the borrower's ability to return the securities.

> **Article Sources**
>
> 1.  Federal Deposit Insurance Corporation. "[FDIC Law, Regulations, Related Acts](https://www.fdic.gov/regulations/laws/rules/5000-2000.html)."
>     
> 2.  The Wall Street Journal. "[How Borrowed Shares Swing Company Votes](https://www.wsj.com/articles/SB116978080268188623)."
>     
> 3.  Federal Reserve Bank of New York. "[FAQs: SOMA Securities Lending Program](https://www.newyorkfed.org/markets/sec_faq)."
>     
> 4.  Federal Reserve Bank of New York. "[Securities Lending](https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/securities-lending)."
>     
> 5.  European Central Bank. "[Securities lending of holdings under the asset purchase programme (APP) and pandemic emergency purchase programme (PEPP)](https://www.ecb.europa.eu/mopo/implement/app/lending/html/index.en.html)."
>     
> 6.  European Central Bank. "[Asset purchase programmes](https://www.ecb.europa.eu/mopo/implement/app/html/index.en.html#pspp)."
>     
> 7.  European Central Bank. "[What is securities lending?](https://www.ecb.europa.eu/ecb-and-you/explainers/tell-me-more/html/securities_lending.en.html)"
>     
> 8.  FINRA. "[FINRA Orders Four Firms to Pay $2.6 Million for Violations Relating to Fully Paid Securities Lending](https://www.finra.org/media-center/newsreleases/2023/finra-orders-four-firms-pay-26-million-violations-relating-fully)."