Securities Lending: What It Is and How It Works

What is securities lending?

Securities lending is exactly what it sounds like: lending securities to someone without selling them. In the case of investors, usually the securities being loaned are things like stocks, but institutions and governments also lend securities for various reasons.

When investors lend securities to other investors, it's a way to make a little money on their stocks and other assets without actually selling them. So, instead of cashing out your shares of XYZ, Inc., you'd basically rent them out to someone else who has an idea and some kind of collateral to back their own play.

Short-selling and securities lending

For retail investors, the most common place that securities lending comes into play is with short-selling. In short-selling, the name of the game is to sell an asset for a bunch of money, then quickly buy it back for a lot less, pocketing the difference. It can be difficult to find enough shares that are for sale to do this with, and sometimes it's just a big headache to collect them, so short-sellers often borrow securities instead of buying them.

When they borrow these securities, like your shares of XYZ, Inc., they're responsible for paying you for the privilege. You may get a little interest or some other kind of consideration, but there is a real risk that your securities will not come back to you, which is why it's still a risky investment move. If you're working with a reputable brokerage, however, your value should be returned even if the actual asset isn't, since they generally require a large amount of collateral to be put down by the short-sellers who will be borrowing your stocks.

Benefits to securities lending for the lender

But what happens if your stocks don't come back to you and you miss out on the joy of compounding value? That's a risk, but the benefits are significant.

Since reputable brokerages require a lot of collateral -- sometimes much more than what the securities are worth at the time of lending -- you should at least get your money back, plus interest and other fees, depending on the type of asset being loaned. This is one way to get some cash out of your investments without actually selling them.

Just like renting out your house during the week you'll be on vacation elsewhere, securities lending allows you to get a little profit from something you weren't really using actively anyway. These "securities rentals" are short-term and come with contracts that spell out the many possible scenarios that could happen and how the borrower will be expected to behave in said situations in order to minimize your risk.

Why securities lending matters to investors

Securities lending is an interesting tactic for many investors, no matter which side they are on in the transaction. For those who lend securities, they're able to help increase the liquidity of the market in general, which can help increase prices overall from the additional buying and selling that can take place, and they get a fee for their trouble.

For short-sellers, securities lending is absolutely necessary for their short-selling to take place. Although they can buy the securities they choose to short, there are often complications in doing so, including simply a lack of available shares at any given time. Remember, these are very short-term holdings, and that means that they often don't have time to wait to buy a million shares of XYZ, Inc., so borrowing them is the next best thing.

Although you may never choose to lend your securities, it's important to understand what this is and what it means for your portfolio if it appears as an option on your brokerage dashboard. Typically, it's a stock thing, but it's also been an option for cryptocurrencies at various times, and governments and other entities may use securities lending even for low-volatility investments like bonds.