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Borrow rate

What Is Borrow Rate?

The borrow rate, also known as the stock loan fee or lending fee, is the annualized interest rate charged by a lender to a borrower for temporary use of a security. This rate is a fundamental concept within securities finance and is central to the practice of short selling. It represents the cost incurred by an investor to borrow shares, typically to execute a short sale, engage in arbitrage strategies, or facilitate the settlement of a trade. The borrow rate is a dynamic figure, fluctuating based on the supply and demand for a particular security in the lending market.

History and Origin

The practice of borrowing securities, and thus the concept of a borrow rate, is as old as stock trading itself. Early forms of securities lending, often informal, existed in the financial markets of London and New York in the late 19th and early 20th centuries, primarily to facilitate the clearing and settlement of trades and later for short selling. Formal equity lending transactions began to emerge in the City of London in the early 1960s, gaining significant prevalence as an industry in the early 1980s.,20

During the 1970s, U.S. custodian banks started lending specific securities to broker-dealers on behalf of their clients.19 The market evolved from a back-office operation to a sophisticated investment practice. Major financial events, such as the 2008 financial crisis, further highlighted the importance of securities lending for market liquidity. In response to pressures faced by primary dealers in accessing term funding and collateral, the Federal Reserve established facilities like the Term Securities Lending Facility (TSLF) in March 2008, which allowed primary dealers to borrow liquid Treasury securities for a fee against less liquid collateral.18,17,16 All loans made under the TSLF program were repaid in full, with interest, by its closure on February 1, 2010.15

Key Takeaways

  • The borrow rate is the cost of borrowing a security, expressed as an annualized percentage.
  • It is primarily paid by short sellers to gain temporary possession of shares they do not own.
  • The rate is influenced by the demand to short a security and the available supply of lendable shares.
  • High borrow rates can indicate strong negative sentiment or limited supply, potentially signaling a "hard-to-borrow" security.
  • Recent regulatory changes aim to increase transparency in securities lending markets, impacting how borrow rates are reported and accessed.

Formula and Calculation

The borrow rate is typically quoted as an annualized percentage of the value of the loaned securities. While there isn't a universal "formula" in the traditional sense for determining the borrow rate, the net cost of borrowing for the short seller often involves the interplay with the rebate rate.

When a security is borrowed, the borrower provides collateral, usually in cash, which the lender then invests. The interest earned on this cash collateral is typically passed back to the borrower, minus the borrow rate (or plus a "short rebate" in some instances).

The effective cost to the borrower can be conceptualized as:

Effective Borrow Cost=Federal Funds RateRebate Rate\text{Effective Borrow Cost} = \text{Federal Funds Rate} - \text{Rebate Rate}

Alternatively, the borrow rate can be seen as the premium charged over the return on the collateral. For example, if the collateral earns the federal funds rate, and the lender rebates some of that to the borrower, the net payment from the borrower to the lender is the effective borrow rate.

In cases where the security is "general collateral" (easy to borrow), the borrow rate might be very low, meaning the rebate rate is close to the federal funds rate. For "specials" (hard-to-borrow securities), the borrow rate can be significantly higher, reflecting the scarcity and high demand, and in extreme cases, the rebate rate can become negative, meaning the borrower effectively pays both the borrow rate and foregoes a portion of the interest on their collateral.14

Interpreting the Borrow Rate

The borrow rate provides crucial insights into the market's perception of a particular security. A high borrow rate indicates that a security is expensive to borrow, often because there is high demand from short sellers or a limited supply of shares available for lending. This can signal strong negative sentiment surrounding the security, as many investors are willing to pay a premium to bet against it. Conversely, a low borrow rate suggests that a security is readily available for borrowing, implying less demand for shorting or ample supply from institutional investors.

Analysts and traders often monitor borrow rates for signs of potential short squeezes. If a security's borrow rate suddenly spikes, it could indicate that short interest is increasing rapidly, making it difficult for existing short sellers to maintain their positions or for new ones to enter. This scarcity can precede a short squeeze, where a rapid price increase forces short sellers to buy back shares, further fueling the rally. The Cboe Global Markets, for example, provides "Borrow Intensity Indicators" that apply machine learning to options market data to generate real-time stock borrow rates and term curves, offering insights into hard-to-borrow conditions.13,12

Hypothetical Example

Consider XYZ Corp. stock, trading at $100 per share.
A short seller believes XYZ Corp. is overvalued and wants to short 100 shares.

  1. Borrowing: The short seller contacts their prime brokerage to borrow 100 shares of XYZ Corp.
  2. Borrow Rate Quoted: The prime brokerage quotes an annualized borrow rate of 5%.
  3. Collateral: The short seller must post collateral, typically 102% of the value of the borrowed shares, in cash. So, $100 x 100 shares x 1.02 = $10,200 in cash collateral.
  4. Daily Cost Calculation: The daily cost of borrowing the shares is calculated based on the annualized rate.
    Annual Borrow Cost = $10,000 (value of shares) * 0.05 (borrow rate) = $500
    Daily Borrow Cost (approx.) = $500 / 365 = $1.37
  5. Rebate (if applicable): Suppose the cash collateral earns a rebate rate of 4.5%.
    Annual Rebate = $10,200 (collateral) * 0.045 = $459
    Daily Rebate (approx.) = $459 / 365 = $1.26
  6. Net Daily Cost: The net daily cost to the short seller is $1.37 (borrow cost) - $1.26 (rebate) = $0.11.
    This daily cost accrues for as long as the shares are borrowed. If the short seller holds the position for 30 days, their borrowing cost alone would be approximately $3.30 (30 days * $0.11). This cost is a critical factor in determining the profitability of a short position.

Practical Applications

The borrow rate is a critical component in several areas of finance and investing:

  • Short Selling Strategy: For hedge funds and other investors engaged in short selling, the borrow rate directly impacts the profitability and feasibility of their trades. A higher borrow rate increases the cost of maintaining a short position, requiring a larger price decline in the underlying security to achieve a profit. It is a key factor in assessing short-selling profitability.
  • Arbitrage Opportunities: In complex arbitrage strategies, such as convertible bond arbitrage or merger arbitrage, the ability to borrow shares at a reasonable rate is essential. Fluctuations in the borrow rate can open or close these opportunities.
  • Market Sentiment Indicator: As noted, a rising borrow rate often indicates increasing short demand, which can serve as a bearish signal for a security. Conversely, a rapidly falling rate might suggest short covering or diminishing bearish sentiment.
  • Risk Management: Financial institutions involved in securities lending use borrow rates as a key pricing input for their lending programs. For borrowers, understanding the potential for borrow rate increases is crucial for risk management to avoid escalating costs on open positions.
  • Regulatory Oversight: Regulatory bodies, such as the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), monitor securities lending activity, including borrow rates. In October 2023, the SEC adopted new Rule 10c-1a, requiring the reporting of certain securities lending transactions to a registered national securities association like FINRA. This rule aims to increase transparency and efficiency in the securities lending market by making aggregate loan data publicly available on a delayed basis.11,10,9,8 FINRA is establishing a Securities Lending and Transparency Engine (SLATE) to implement these reporting requirements.7

Limitations and Criticisms

While the borrow rate offers valuable insights, it has certain limitations and faces criticisms:

  • Transparency Issues (Historically): Traditionally, securities lending markets have operated over-the-counter (OTC), with less transparency than exchange-traded markets. This lack of centralized data made it difficult for market participants to ascertain prevailing borrow rates accurately, leading to potential inefficiencies. The SEC's Rule 10c-1a aims to address this by mandating reporting, but the full impact on transparency is still unfolding.6
  • Incomplete Information: The publicly available borrow rate might not always reflect the true, real-time cost for every market participant. Well-connected short sellers or large prime brokerage clients may negotiate lower rates than the general market average due to their relationships or volume. Research suggests that connected borrowers might overcome search costs and negotiate lower fees.5
  • Proxy for Shorting Constraints: While high borrow rates often correlate with short-sale constraints (where investors struggle to borrow shares), they are not a perfect proxy. Other factors, such as the total lendable supply and the willingness of existing shareholders to lend, also contribute to the ease or difficulty of borrowing. Some academic research explores the relationship between short interest, institutional ownership, and short-sale constraints, finding that constrained stocks may underperform.4,3
  • Impact on Market Efficiency: Critics argue that high borrow rates, by increasing the cost of shorting, can hinder price discovery and market efficiency. When it is expensive to bet against overvalued securities, their prices may remain inflated for longer, potentially leading to mispricings.

Borrow Rate vs. Short Interest

While closely related, the borrow rate and short interest represent distinct aspects of short selling activity.

FeatureBorrow RateShort Interest
DefinitionThe annualized fee charged to borrow shares.The total number of shares of a security that have been sold short and not yet repurchased.
NatureA cost or price.A quantity or volume.
SignificanceReflects the cost of betting against a stock; indicates supply/demand dynamics in the lending market.Reflects the magnitude of bearish bets; indicates overall market sentiment and potential for short squeeze.
AvailabilityOften quoted in real-time by brokers; aggregate data becoming more public due to new regulations.Typically reported twice a month by FINRA on a delayed basis.2
InterpretationA higher rate means it's more expensive to short, often due to scarcity or high demand.Higher short interest indicates a larger number of investors betting against the stock.

The borrow rate is a measure of the expense associated with initiating or maintaining a short position, directly reflecting the dynamics within the securities lending market. Short interest, conversely, is a cumulative measure of the total outstanding short positions. While a high borrow rate often accompanies high short interest (especially for "hard-to-borrow" stocks), it's possible for a stock to have high short interest but a relatively low borrow rate if there is ample supply of shares available for lending.

FAQs

How does the borrow rate affect short sellers?

The borrow rate is a direct cost for short sellers, impacting the profitability of their trades. A higher borrow rate means they must pay more to hold their short positions, requiring a larger decline in the security's price for the trade to be profitable.

What causes the borrow rate to change?

The borrow rate fluctuates based on the supply and demand for a particular security in the lending market. High demand from short sellers and limited availability of shares to lend will push the borrow rate higher. Conversely, low demand and ample supply will result in a lower rate. Other factors include market liquidity and general interest rates.

Is a high borrow rate a bullish or bearish sign?

A high borrow rate is generally considered a bearish sign for the security itself, as it indicates strong negative sentiment and a high demand to short the stock. However, it can also be a bullish sign for existing long positions if it suggests the potential for a "short squeeze," where short sellers are forced to buy back shares, driving the price up.

How can investors find borrow rate information?

Historically, borrow rates were often proprietary information held by broker-dealers. However, with increasing regulatory transparency, such as the SEC's Rule 10c-1a, more aggregate data is becoming publicly available through registered national securities associations like FINRA. Some data providers and exchanges, like Cboe Global Markets, also offer real-time borrow rate indicators, often derived from options market data.1