Cash vs Non-Cash Collateral in Stock Loan

When a broker lends out a stock to a short seller, the borrower must post collateral so the lender isn't exposed if the borrower defaults. In the US, that collateral is almost always cash, sized slightly above the value of the borrowed stock. In Europe and Asia, non-cash collateral — other securities like government bonds — is far more common instead.

The economics of the loan differ depending on which is used. With cash collateral, the lender invests the cash (often overnight) and pays the borrower back a "rebate rate" that is lower than what the lender earns on the reinvested cash — the spread is the lender's fee, and it can even go negative for hard-to-borrow stocks, meaning the borrower pays the lender directly rather than receiving a rebate. With non-cash collateral, there's no cash to reinvest, so the lender simply charges a flat borrow fee instead, and takes on no reinvestment risk but does take on the risk that the pledged securities themselves lose value.

Worked example

A hedge fund borrows $10 million of an easy-to-borrow stock and posts $10.2 million cash as collateral (a 2% haircut). The lender reinvests that cash overnight at 5.0% and rebates the borrower 4.7%, keeping the 0.3% spread as its fee. If the same loan were instead collateralized with government bonds, there would be no reinvestment or rebate at all — the borrower would simply pay the lender a flat annualized fee of roughly 0.3%, landing at a similar economic outcome through a completely different mechanism.