Bank-backed broking houses expect client influx after Karvy fiasco

Trust deficit after Karvy fiasco and access to margin facility to drive shift of investors

Bank-backed broking houses are expecting to corner a significant chunk of market share as investors, driven by safety concerns for their investments after the Karvy episode, shift their accounts from smaller broking houses. 

At present, the top-four bank-backed brokerages account for one-fourth (a 25 per cent market share) of active clients.

“Over the last month, we have gained in terms of accounts. There are customers who are moving their accounts to us. Also, fresh accounts are being opened,” said Dhiraj Relli, managing director and chief executive officer of HDFC Securities. 

“As a result of the Karvy fallout, investors are looking for broking houses where there is more assurance of fund protection,” he said. 

Meanwhile, smaller broking houses are bracing up for higher operating costs, as the Securities and Exchange Board of India (Sebi) is mulling stringent norms to pre-empt another Karvy-like episode, according to industry sources.

“We expect compliance costs to go up, which would make the environment more challenging for us,” said the head of a small-sized broking house. 

Industry players say the Karvy episode underscored the risk of margin funding, which had emerged as a source of income for some of the brokers. “The share of income from the margin funding book was as high as one-fourth of total income in some cases,” said a market participant. The yields on the margin funding book ranged between 12 per cent and 18 per cent.

However, this source of income can quickly deplete for non-bank broking houses following Sebi’s move to crack down the practice of brokers accepting clients’ shares as collateral for giving them margin facility. 

“With Sebi tightening norms on managing client funds as float or pledge on client shares, direct lending by brokers to clients in the form of allowing overdue will disappear. Brokers need banks or non-banking financial companies (NBFCs) tie-up, as they can only take pledge of client shares to fund the client,” ICICI Direct pointed out in a note. 

Relli said: “Bank-backed broking houses, by virtue of being AAA-rated, can get access to funds at a lower cost, if needed, and extend margin facility to clients.” 

Smaller brokers say Sebi’s new norms requiring upfront margins from investors (for both buying and selling) would also hurt them, as they are likely to opt for brokers which are placed well to offer margin facility.

Brokers also cite sharp dip in cash volumes — which offer relatively higher margins — for deteriorating profitability. Cash volumes as share of average daily turnover are little over 2 per cent, showed the note from ICICI Direct. Meanwhile, the higher-margin delivery trades have diminished further, with their share in cash volumes hovering at a 10-year low.

From 5,899 in 2014-2015, the number of brokers in the cash market stood at 2,734, or 53 per cent lower, as of December 31, 2018, showed the Sebi data.

“The cash market has not grown. There is a sharp divergence between growth of cash markets and the overall economic growth in the last few years,” said Rajesh Baheti, managing director of Crosseas Capital Services. 

To further complicate matters, the competitive intensity from the emerging class of discount brokers is making it difficult for smaller brokerages to gain traction in the derivatives segment, where volumes are much higher. 

Discount brokers offer a flat fee for trades, which is a big draw for retail traders looking for arbitrage opportunities on derivative instruments, such as futures and options. 

As share of average daily turnover, derivative volumes account for 97 per cent, showed the ICICI Direct note. 

While wider participation in derivatives has helped discount brokers post strong growth over the last few years, discount brokers acknowledged that after a point, the stability of product would be more important than just the transactions costs. 

“We have been working on making our product better for the last four-five years. And the quality of the product matters more than transaction cost after a point,” said Nithin Kamath, founder and chief executive officer of Zerodha.