Securities Lending For Dummies
Non-recourse stock loans can be very appealing to investors because they come with little risk.
not be able to pay back the loan, the lender keeps the collateral. This is the only form of recourse the lender may resort to, and anything more would be forbidden by the terms of the loan. Since the collateral is something that is given freely before the loan begins, these are considered “non-recourse” because of the lack of action taken by the lender against a defaulting borrower.
It is important to remember that many non-recourse lenders are unregistered and/or unregulated, and whether or not the lending agency is financially solvent is often difficult to ascertain. Furthermore, lenders do not truly hold onto the stocks they obtain as collateral, but rather use them as if they own them, often selling them for a profit. At the end of the loan period, it is understood that the lenders must provide the stocks, along with a portion of any profits, to the borrower; however, many lenders are often unable to do so due to poor investment choices.
It is also important for any potential borrowers to remember that unregulated loans may be interpreted differently by the Internal Revenue Service. Where the borrower and lender see a loan, the IRS may see a sale of stock and tax the transaction. This is especially true when the lender sells the stock while in their possession or when the borrower chooses to default on repayment due to the stock having depreciated in value. This would essentially mean that they received money for the stock that was never taxed, something the IRS would aim to correct.