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Securities lending is the act of loaning a stock or other security to an investor or firm.

When a security is loaned, the borrower puts up collateral in the form of cash, a security, or a letter of credit. Title and ownership is transferred to the borrower. In short selling, investors borrow a security to sell with the plan to profit by buying it back at a lower price.

Institutional investors such as hedge funds and ETFs are the biggest lenders of securities. Securities lending has become common because it can provide nice returns and make markets more efficient. But there are risks.

An ETF may have thousands of shares of stock available to loan. A short seller pays the ETF a fee and posts collateral for the right to do so. But if the shorted security rallies, the borrower might default. The collateral also might not cover the ETF’s cost, or the ETF may invest that collateral in something that loses value.

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