Regulation T (Reg T)
What Is Regulation T?
Regulation T is an assortment of provisions that oversee investors' cash accounts and the amount of credit that brokerage firms and dealers might reach out to customers for the purchase of securities. As indicated by Regulation T, an investor might borrow up to half of the purchase price of securities that can be bought utilizing a loan from a broker or dealer. The excess half of the price must be funded with cash.
Grasping Regulation T (Reg T)
Buying securities with borrowed money is generally alluded to as buying on margin, which alludes to assets that an investor must deposit with a broker-dealer to get a loan. Also, Regulation T proclaims payment rules on certain securities transactions made through cash accounts.
Regulation T, or Reg T, was laid out by the Board of Governors of the Federal Reserve System to give rules to extensions of credit by brokers and dealers and to manage cash accounts. An investor who has a cash account can't borrow funds from a broker-dealer and must pay the purchase price of securities with cash.
Margin accounts, then again, permit investors to get credit to fund a portion of their securities purchase. Since buying securities on credit can open investors to sudden losses of a lot bigger extent contrasted with a similar purchase utilizing just cash, the Federal Reserve Board stepped in and proclaimed a rule that limited the borrowing to be no greater than half of the securities purchase price.
The half requirement is called the initial margin on the grounds that it lays out a base borrowing level at the hour of purchase. Certain brokers might have stricter requirements, with levels above half.
Regulation T limits the amount of credit an investor can get from their broker to buy securities on margin.
Special Considerations
While the primary goal of Regulation T was to oversee margin, it likewise presented transaction rules for cash accounts. Since it requires as long as two days for securities transactions to settle and the cash proceeds to be delivered to the seller of securities, a situation can emerge when an investor buys and sells similar securities before paying for them from the cash account. This is called freeriding, and it is precluded by Reg T.
In such cases, the investor's broker must freeze the cash account for 90 days, requiring the investor to fund their securities purchases with cash on the date of the trade.
Illustration of Reg T
An investor who wishes to purchase securities utilizing broker-dealer credit must apply for a margin account that awards borrowing privileges. At the point when investors borrow money in their margin account, they must pay interest in view of the rate schedule laid out by the broker-dealer.
Assume an investor wishes to get a loan from a brokerage firm to purchase 10 shares of a certain company with a price for every share of $100, bringing about a total purchase of $1,000. Regulation T states that the investor can borrow something like half of the purchase price, or $500, from the broker, while the excess balance must be paid in cash.
Features
- Regulation T administers cash accounts and the amount of credit that broker-dealers can reach out to investors for the purchase of securities.
- Reg T orders that investors can borrow something like half of the purchase price while the excess balance must be paid in cash.
- Investors who need to purchase securities utilizing broker-dealer credit need to apply for a margin account.
