Badla Returns

With badla rates hovering high, badla financing is a viable investing option for the cash-rich investor, at least till financial institutions and banks are not allowed

The bull run on the BSE in the past three weeks has seen a number of stocks hitting new highs. With brokers and operators taking large forward positions, there was a temporary liquidity problem in the market which saw the badla charges move up to 45 per cent in the previous settlement against 26 per cent for the last settlement in March. Badla rates are fixed by the demand and supply of funds and generally there is a shortage of funds in the market, which results in badla rates shooting up.

In order to improve liquidity on the markets, the BSE has put foward a proposal to the Reserve Bank of India to allow banks and financial institutions to enter the business of badla financing. This proposal has generated a lot of enthusiasm among the broking community as this will lead to lower badla charges on improve liquidity.

Meanwhile, brokerage houses have already taken a lead in this direction by tapping retail investors for badla financing. For cash-rich retail investors (with a minimum investment of Rs 100,000), it is a good opportunity to earn excellent returns in the short term as returns from other investments avenues are much lower than those offered by badla financing. Says Mihir Sheth of Mumbai-based broking firm Prabhudas Lilladher, The liquidity, security and the assured returns are very attractive for the individual investors.

If banks and financial institutions are permitted to invest in the carry forward market, it will provide the market with liquidity and reduce badla rates. Says Sheth, The market will become dynamic as the high badla rate that are being seen in the market will fall down to a reasonable 18-20 per cent levels. In the present scenario, even these rates are very attractive.

This proposal will provide the banks and financial institutions with an attractive short term investment avenue. The returns from this investment opportunity are much better than returns offered by any other short term investment considering the reduced riskiness of investing in this market. This will also lead to a greater integration of the stock market with other financial markets. This will help in reducing the risk of a few big operators being able to manipulate the market.

The present badla system in its re-introduced form is considered much safer than its earlier version. The major drawbacks of the previous badla system was the lack of transparency in the system, poor monitoring of the transactions and the kind of leverage that one can get was instrumental in the stock market scam of 1992. But most of these anomalies have been rectified by the G S Patel Committe and Verma Committee, which have been implemented by Sebi with certain modification.

In the new scheme, every transaction has to be demarcated at the end of the day for delivery, jobbing and carry forward with trading on members account shown separately. One of the important step has been that no transaction be carried forward beyond 90 days. Also, broker-wise outstanding positions limit has been fixed with an overall limit of Rs 20 crore and sub-limits on sale and purchase on every scrip. Another important stipulation by Sebi was that the brokers should have a capital adequacy of 6 per cent for corporate members and 3 per cent for brokers.

Transparency has been brought in to a large extent in the market with the advent of screen based trading which was needed for the success of the revised carry forward mechanism. The presence of the clearing corporation in the carry forward transaction has reduced the risk of default to a great extent. The clearing corporation ensures that even if one member defaults, the counter-party still gets compensated by way of auction or from the trade guarantee fund. Thus the market remains insulated from the default. For vyaj badla transactions, the share certificates have to be deposited with the clearing corporation thereby ensuring liquidity. The creation of trade guarantee fund imparts liquidity to the affected party if one of the members defaults on his commitment.

With the entry of dematerialised trading in equity, the risk of duplicate or stolen shares being used for trading has been reduced to an extent. The market has been broadened with the addition of 120 stocks in the forward, increasing the number of stocks in this category to 154 scrips. This has widened the possible investment avenues for the investors. Though, stock lending has been legally permitted, it is yet to start. If this takes place, investors will have another opportunity to make profits. One inherent risk with stock lending is that the borrower might return counterfiet or stolen shares which can be prevented if stock lending is done in dematerialised form.

The increased transparency, presence of clearing corporation, presence of trade guarantee fund and dematerialised equities make badla financing an attractive investment opportunity for the retail investor. Considering the risk profile of this investment, the rates are very attractive for short term. Finally, a word of caution, investors have to evaluate the broker with whom they are entrusting the money.