Definition: The Lending Margin refers to the gap between the value of the property mortgaged, against which the loan is borrowed, and the actual amount advanced to the borrower.
In the above definition, Margin denotes the collateral that the investor has to deposit with a bank so as to cover some or all the credit risk as posed on the banks by the borrower. The risk arises if the holder has borrowed funds from the bank, entered into the derivative contract or has sold the financial instruments short.
The banks often lend money against a mortgage of property Viz., Building, land, shares, the stock of goods, jewelry, etc. Only a certain percentage of the value of a mortgaged property is provided in the form of a loan. For example, if the value of a building is Rs 50 million and the amount advanced is only Rs 30 million, the lending margin is 40 percent (50-30/50 * 100).
The central bank has the power to increase or decrease the lending margin with a view to increasing or decrease the bank credit. Such as, when the central bank decides to reduce a bank credit to overcome the inflation, raises the lending margin. On the contrary, when the central bank decides to increase the bank credit cuts down the lending margin.
This method was used for the first time by RBI in 1949 with an objective to control the speculative activity in the stock market. Since then, it has been used frequently with a view to preventing speculations in the agricultural products such as cotton, oilseeds, food grains, sugar, vegetable oil, etc. However, it is important to note that the selective credit controls had been eliminated in October 1996.