DEFINITION of 'Securities-Based Lending'

The practice of making loans using securities as collateral. Securities-based lending (SBL) provides ready access to capital that can be used for almost any purpose such as buying real estate, purchasing personal property like jewelry or a sports car, or investing in a business. The only restrictions are other securities-based transactions like buying shares or repaying a margin loan. Also known as securities-based borrowing, non purpose lending or securities lending, SBL is separate and distinct from "securities lending." Securities-based lending became increasingly popular with U.S. broker-dealers and banks from 2011 onwards as an additional revenue stream, facilitated by the steady rise in equities and record-low interest rates.

BREAKING DOWN 'Securities-Based Lending'

Securities-based lending has a number of benefits for the borrower. It precludes the need to sell securities, thereby avoiding a taxable event for the investor and ensuring continuation of the investment strategy. SBL offers access to cash within a couple of days and at lower rates of interest than a home equity line of credit or second mortgage, and also has a great deal of repayment flexibility. These advantages are offset by the inherent volatility of stocks that makes them a less than ideal choice for loan collateral, and the risk of forced liquidation if the market falls and collateral value plunges. Nevertheless, SBL works best when used for short periods of time in situations that demand a significant amount of cash quickly, such as an emergency or a bridge loan.

SBL also provides a number of benefits to the lender. It offers an additional and lucrative income stream without much added risk. The liquidity of securities used as collateral and the existing relationships with typically high net worth clients who use the SBL facility also mitigates much of the credit risk associated with traditional lending.

Although securities-based lending, under the right circumstances, can be a win-win for borrowers and lenders, its growing usage has led to concern because of its potential for systematic risk. In 2016, Morgan Stanley (which is one of very few to release SBL numbers) reported sales of security backed loans worth $36 billion — a 26% increase compared to the year before — and as the interest rate continue to increase, financial expert are becoming increasingly concerned that when the market turns, there will be considerable fire sales and forced liquidations.

Securities lending is not tracked by the SEC nor FINRA — though both have warned investors of the risks — and ​can be considered to be a shadow banking activity. In April, 2017, Morgan Stanley settled a case in which Massachusetts' top securities regulator accused the bank of encouraging brokers to push SBL in cases where it wasn't needed, and with that ignoring the risks involved.

Since the financial crisis in 2007-2008, this has been an area of strong growth for investments banks, and it is partially offsetting declining fees. Some are seeking to offer these loans to millions of Americans with accounts managed by broker-dealers – hence making its way to Main Street (SBL is currently reserved for "ultra-wealthy" clients).

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