What is Securities-Based Lending?

Securities-based lending is 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," securities-based lending is separate and distinct from "securities lending." 

Key Takeaways

  • 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.
  • 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. It 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.
  • Securities-based lending 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.

How Securities-Based Lending Works

Since the financial crisis in 2007-2008, securities-based lending has been an area of strong growth for investment banks and has partially offsetting declining fees. Such non-purpose loans are being offered to millions of high-net-worth individuals via their accounts managed by broker-dealers. Securities-based lending accounts and balances have surged since 2011, facilitated by the steady rise in equities and record-low interest rates. Such credit has become popular because it tends to be easier to obtain and requires far less documentation than a traditional loan. Borrowers can get cash within just a few days in most cases. It is also relatively cheap; the rate borrowers are charged is generally variable based on the 30-day London Inter-Bank Offered Rate (LIBOR). Typically, the interest rate is 2-5 percentage points above LIBOR depending on the sum. Such non-purpose loans may also be used to cover tax payments, vacations or luxury goods. 

Securities-Based Lending Benefits

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.

Example of Securities-Based Lending

Let's say an individual is looking to do a large renovation on her home to the tune of $500,000. She first reaches out to her bank for a standard loan for the $500k and the rate quoted is 5% APR. However, since she has a stock portfolio of blue chip companies worth $1,000,000, she can pledge those securities against the loan and receive a better interest rate of 3.25% APR.

The lender sees the pledged securities as another layer of protection and thus offers a much lower interest rate for that protection. The borrower likes this scenario because the stock portfolio is allowing her to borrow at a lower rate, while keep the stocks invested. She also receives the loan quicker than she would have with a standard loan.

Securities-Based Lending Risks

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 companies to release SBL numbers) reported sales of security-backed loans worth $36 billion — a 26% increase compared to the year before. As interest rates continue to increase, financial experts are becoming increasingly concerned that when the market turns there could be fire sales and forced liquidations.

Securities lending is neither tracked by the Securities and Exchange Commission (SEC) nor the Financial Industry Regulatory Authority (FINRA), though both have warned investors of the risks. 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.