Stephen Ryan highlights the risk of margin loansIn recent weeks the media has been informing us that margin lending has jumped for the first time in three years, with investors trying to benefit from the latest sharemarket rally. Banks are reporting twice as much interest in new margin loans compared to last year.

In the margin lending business, financiers take on baskets of stocks as collateral against loans used to buy other stocks. Margin loans allow investors to have a leveraged exposure to share markets, which magnifies the potential gain when equity prices increase.

Lenders would have you believe that if you are a “savvy investor”, you’ll understand that the return should exceed the borrowing cost and hopefully become a growth engine.

However, we also need to remember that leveraging in this way also magnifies the potential losses. I would suggest that the very high risk of borrowing against a volatile asset to buy more volatile assets when the market is at a high, breaches common sense principles of investment.

With term deposits and cash rates squeezed, it is understandable that investors seek alternatives. The sharemarket is not inappropriate, however borrowings invested in equities should be secured against a stable asset, such as property, rather than assets which will be ravaged by the bank if a margin call is triggered.

Let’s not so quickly forget some of the margin lending casualties of the Global Financial Crisis.