Information > Financial Terms > This page

Margin Buying 
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

When the purchaser furnishes only a specified fraction of the total purchase price of the securities bought and the broker furnishes the balance, charging interest on that amount (the debit balance) until the customer either sells the stock or pays off the loan and thus takes up the stock.  The broker in turn may obtain the funds for carrying margin accounts from banks by rehypothecating the securities bought on MARGIN by customers with the customer's permission, granted in advance in the customer's agreement for opening a MARGIN ACCOUNT.

With the passage of the SECURITIES EXCHANGE ACT OF 1934, on June 6, 1934 , margin requirements on national securities exchanges became subject to regulation by the Board of Governors of the Federal Reserve System, Section 7(a) of the act states the objective of such regulation:

"For the purpose of preventing the excessive use of credit for the purchase or carrying of securities, the Federal Reserve Board shall, prior to the effective date of this section and from time to time hereafter, prescribe rules and regulations with respect to the amount of credit that may be initially extended and subsequently maintained on any security (other than an exempted security) registered on a national securities exchange."  The purpose is to prevent the excessive use of credit, not to influence the level or trend of stock prices.  Also, the board is given power in the act to prescribe initial as well as maintenance margins; it has prescribed only initial margins from the beginning of such regulation.

Regulation T of the board of governors, pursuant to Sections 7 and 8(a) of the act, became effective October 1, 1934.  It applies to extension and maintenance of credit by every member of a national securities exchange and to every broker and dealer who transacts a business in securities through the medium of any such member.

On May 1, 1936, Regulation U of the board of governors, pursuant to Section 7 of the Securities Exchange Act of 1934, became effective.  It applies to loans by banks for the purpose of purchasing or carrying any stock registered on a national securities exchange.

Regulation G of the board of governors, "Collection of Noncash Items", was revoked effective September 1, 1967, when the board of governors concurrently revised its Regulation J, "Collection of Checks and Other Items by Federal Reserve Banks."  A new regulation G was promulgated by the board of governors, effective March 11, 1968, applicable to credit by persons other than banks, brokers, or dealers for the purpose of purchasing or carrying registered equity securities.

Regulation X of the board of governors was adopted by the board in 1971 to carry out provisions of the Foreign Bank Secrecy Act of 1970.  Regulation X implements Section 7(f) of the act and generally applies to borrowers obtaining credit from within the United States or borrowers obtaining credit from outside the United States who are 1. United States Persons, 2. foreign persons controlled by United States persons, or 3. foreign persons acting on behalf of or in conjunction with United States persons.

Special margin requirements for bonds convertible into stocks were also adopted by the board of governors effective March 11, 1968.

Effective July 8, 1969, Regulations T, U, and G were amended principally to implement the provisions of P.L. 90-347, adopted in regulations to cover credit extended for the purchase of over-the-counter stocks having specified market activity characteristics and company size and stock distribution criteria, and bonds convertible into such stocks (the board of governors issues the limit of such specific over-the-counter stocks).

Regulations T, U, G, and X limit the amount of credit to purchase and carry margin stocks that may be extended on securities as collateral by prescribing a maximum loan value which is the specified percentage of the market value of the collateral at the time the credit is extended; thus margin requirements are the difference between the market value (100%) and the maximum loan value.


Section 8 of the act makes it unlawful for any member of a national securities exchange, or any broker or dealer transacting business in securities through the medium of any such member, to borrow in the ordinary course of business on any security (other than an exempted security) registered on a national securities exchange except (1) from or through a member bank of the Federal Reserve System, (2) from any nonmember bank which shall have filed with the Board of Governors of the Federal Reserve System an agreement undertaking to comply with all provisions of the act, or (3) in accordance with any rules and regulations of the board of governors permitting loans between such members and such brokers or dealers.

Exempt securities ( U.S. government securities, direct or guaranteed; state and municipal securities; etc.) are not subject to the margin requirements of Regulation T.  Thus the much lower margins prescribed by the New York Stock Exchange would apply to its members as minimum margins on such exempt securities.


Since members of national securities exchanges and brokers or dealers doing business through them must borrow from member banks of the Federal Reserve System or nonmember banks which have agreed to abide by the act, the Board of Governors of the credit at the bank level by Regulation U, which reaches borrowing by brokers and direct borrowing by customers on purpose loans (loans to finance the purchasing or carrying of securities on margin).

Regulation U controls loans from banks by brokers both for the latter's own accounts and for the purpose of financing customers' margin accounts; loans to brokers for their own accounts are subject to the Regulation U margin requirement (set by the board of governors), but loans to brokers representing rehypothecation of customers' securities carried for the account of such customers are not subject to Regulation U margin requirement (set by the board of governors), instead being subject to the bank's own voluntary margin requirements (varying with the quality, mix, and market characteristics of the securities offered as collateral), which normally are less than the board's margin requirement.

Other bank loans on securities collateral exempt from the Regulation U requirement on margin include loans by banks to any bank, loans to dealers to aid in the distribution of securities to customers (not through an exchange), loans to brokers and dealers to meet emergencies, day loans, loans to finance arbitrage transactions of emergencies, day loans, loans to finance arbitrage transactions of customers of the broker, or loans to odd-lot dealers.

Non-purpose loans, i.e., loans not for the purpose of purchasing or carrying securities on margin, are exempt from Regulation U margins,  the bank's own voluntary margins applying, even if the securities are registered on a national securities exchange and non-exempt if used for purpose loans.  Such loans are extended to firms and individuals for a variety of purposes.  An administrative problem arises in connection with proper policing of such nonpurpose loans to ensure that this type of loan on securities does not develop into a loophole for circumvention of Regulation U.

Regulation U applies specifically to the making by banks of any loans secured directly or indirectly by any stock for the purpose of purchasing or carrying any stock registered on a national securities exchange.  Thus, it does not apply if the purpose is to finance the exchange, or any unlisted stocks or bonds.  The bank's own voluntary margins would apply in such cases.  For example, convertible bonds listed on a national securities exchange could be purchased by an individual and financed by a bank loan at the bank's own margin requirement, and Regulation U would not apply even if the convertible bonds were converted into a stock listed on a national securities exchange during the duration of the loan.

Other Lenders.  

Persons other than banks, brokers, or dealers who in the ordinary course of business extend or arrange to extend credit totalling $50,000 or more in any calendar quarter, or have outstanding at any time during the calendar quarter a total of $100,000 or more in such credit, secured directly or indirectly, in securities, are subject to the provisions of Regulation G, including registration with the Board of Governors of the Federal Reserve System through the district Federal Reserve bank.  Among the provisions of the regulation is that Regulation G lenders obtain from the borrower a signed statement providing for, among other things, an indication of the purpose of any stock-secured loan, that they determine in good faith that the statement was correct, and that they sign it as so accepted.  This requirement also applies to banks (Regulation U), but since loans by brokers or dealers generally are for the purpose of purchasing or carrying securities, no statement of purpose would ordinarily be required in connection with such loans.

Regulation X.  

Title III of the Foreign Bank Secrecy Act (P.L. 91-508) which was enacted October 26, 1970 to become effective November 1, 1971, made margin regulations of the Board of Governors of the Federal Reserve System for the first time directly applicable to U.S. borrowers and to foreign borrowers controlled by them or acting for them.  In July 1971, the board of governors published for comment proposed amendments to its Regulation T, U, and G, to implement the new statute.  The board of governors reports that the comments received prompted it instead to combine the changes in a new regulation, designated Regulation X.

The board of governors summarizes Regulation X as in essence providing that subject borrowers obtaining credit in the U.S. or abroad must comply with the margin regulation applicable to the lender, or if none applies, they must treat the borrowing as if it were subject to Regulation G, the margin regulation applicable to extensions of credit by persons other than banks, brokers, or dealers.  Exemptions were provided for (1) individuals permanently resident abroad who obtain $5,000 or less in purpose credit (for the purpose of purchasing or carrying securities on margin) at any one time or in any one year, (2) foreign subsidiaries of U.S. corporations making markets in Eurobonds, and (3) extraordinary circumstances in which the board of governors may deem it justifiable to grant individual exemptions by order, if the obtaining of the credit is consonant with the purpose of the Foreign Bank Secrecy Act.

Leverage in Margin Buying.  

With high margin requirements, the leverage possible on margin trading is low.  The purpose of buying on margin is to increase the possibility of gain with available cash.  The advantage of buying on margin can be illustrated by the following example.  Assume a speculator with cash of $10,000 wishes to purchase as much as possible of a certain stock selling at $100 per share.  If he bought the stock for cash and delivery, he would be able to buy only 100 shares (ignoring commission costs).  On a 10% margin, however such as prevailed in the late 1920s, he would be able to buy 1,000 shares, the broker putting up $9,000 and the speculator $1,000 per 100 shares.  In this way, the speculator could purchase ten times as much stock as he could by purchasing it outright.  If the stock rises one point, a profit of $1,000 is made, whereas in an outright purchase the profit would be only $100.  This advantage of leveraged possibility of gain, however, is offset by the disadvantage of equal possibility of loss, and therein lies the danger of low margins.  If the stock declines one point, the speculator loses $1,000.  The broker will carry the stock provided there is adequate margin to protect the account; a broker will rarely carry a stock until the minimum maintenance (percentage) margin of the New York Stock Exchange is reached (25%), particularly in an active and rapidly declining market.

When a customer's percentage equity in a margin account falls below a level considered adequate by the broker, a MARGIN CALL is sent to the customer; if there is not a prompt response, the broker has the right to sell out the customer either wholly or partially, the latter in order to restore the account to a properly margined position.  The customer under New York Stock Exchange rule may not be permitted by a member firm to make a practice of effecting transactions requiring initial or additional margin and then furnishing such margin by liquidation of the same securities or other securities.  The required margin must be obtained as promptly as possible, but in any event before the end of the four full business days following the date of the transaction.  Cash will of course cover the margin call; if securities are used, they must be listed securities with the necessary loan value; e.g. with 50% margins, the loan value is 50% of market value of such securities tendered in response to a margin call.

Restricted Accounts. 

An unrestricted account is one whose percentage equity is at least the prevailing board of governors' initial margin.  A restricted account is one whose equity percentage has dropped below the board's initial margin; the board's regulation does not require that a margin call be sent to the customer to restore the margin to the initial margin level, but it does restrict the freedom of action of the customer with respect to such an account.  Some of the restrictions are as follows.

The general rule is that no withdrawal of cash or registered or exempted securities will be permitted if the adjusted debit balance of the account would exceed the maximum loan value of the securities in the account after such withdrawal.

The following exceptions to the general rule are available only in the event no cash or securities need to be deposited in the account in connection with a transaction on a previous day, and none would need to be deposited thereafter in connection with any withdrawal of cash or securities on the current day:

1.                 Registered or exempted securities may be withdrawn upon the deposit in the account of cash (or registered or exempted securities counted at their maximum loan value) at least equal to the retention requirement (50% of current market value for registered securities other than exempted issues and maximum loan value for exempted securities) of the securities withdrawn.

2.                 Cash may be withdrawn upon the deposit in the account of registered or exempted securities having a maximum loan value at least equal to the amount of cash withdrawn.

3.                 Upon the sale (other than short sale) of registered or exempted securities in the account, there may be withdrawn in cash an amount equal to the difference between current market value of the securities sold and the retention requirement of those securities.

Substitutions in a restricted account, i.e., changes in holdings by purchases and sales on the same day, may be made provided the net result would not cause any change in the status of the account in regard to existing margin requirements.

Special subscription accounts, in connection with the exercise of stockholders' rights to subscribe to additional shares, call for satisfaction of initial and maintenance margin requirements and thereafter for four quarterly payments equal to 25% of the difference between initial equity in the account and initial margin percentage of market value of the stock at the time of the subscription.

Special miscellaneous accounts may be credited with the excess over margin requirements in a margin account occurring by reason of a rise in market value (which must be withdrawn on the same day it occurs) or dividends (which must be withdrawn in 35 days).

NYSE Margin Trading.  

The New York Stock Exchange (NYSE) points out that prior to July 8, 1969, brokers were permitted to extend regulated credit on stocks and convertible bonds listed or traded only on registered exchanges.  Effective July 8, 1969, the Federal Reserve amended the regulations to permit brokers also to extend regulated credit on a selected list of stocks traded over the counter (OTC).  OTC margin stocks are those determined by the Board of Governors of the Federal Reserve System to have characteristics similar to stock registered on national exchanges.  

Back to Information