A broker loan is usually described as a loan granted to a broker or brokerage firm by a bank. This money is typically lent for the purpose of financing margin accounts, building inventories of stocks, or funding the underwriting of securities offered for the first time. A broker loan may be extended for various other reasons as well.
Often, an individual investor will seek a loan from an investment broker for the purpose of funding the purchase of securities. To purchase securities in this manner, an investor must have a margin account. This margin account allows him or her to obtain securities without providing money at the time of purchase. In order to fund margin accounts for investment clients, a brokerage firm may seek a broker loan from a banking institution.
A broker may also seek a broker loan for the purpose of underwriting new issues. A new issue is a security that is being offered to the public for the very first time. To qualify as a new issue, a security must meet specific Securities and Exchange Commission (SEC) requirements.
Broker loans are also granted to fund the purchase of securities by a brokerage firm itself. Often, brokers choose to purchase securities in order to build an inventory. Additionally, this type of loan may be used to fund the acquisition of desired assets for the firm's own portfolio.
The interest rate charged by the bank for lending money to a broker is called the broker loan rate. This rate is charged regardless of the reason for obtaining the loan. The interest rate on broker loans is about one point higher than short-term interest rates.
A broker loan is callable with just 24-hour notice. This means the loan is payable on demand, with only one day's notice. Since broker loans are callable, the broker loan rate is frequently referred to as the call money rate.
Sometimes the term broker loan is used to refer to a loan extended by a broker to an investor. This type of broker loan is used to fund the borrower's securities purchase. An investor may be able to borrow as much as 50 percent of the market value of the securities in question. This type of loan is completely different from those made to brokers and is not charged the same broker loan or call money rate.