Presentation on BADLA SYSTEMBY

APURV BHARDWAJ

SUSAN THOMAS

BADLA System

•Badla was an indigenous carry-forward system invented on the Bombay Stock Exchange as a solution to the perpetual lack of liquidity in the secondary market

•Badla is a mechanism to avoid the discipline of a spot market; to do trades on the spot market but not actually do settlement

•The "carry forward" activities are mixed together with the spot market

Badla trading involved buying stocks with borrowed money with the stock exchange acting as an intermediary at an interest rate determined by the demand for the underlying stock and a maturity not greater than 70 days

Like a traditional futures contract, badla is a form of leverage; unlike futures, the broker—not the buyer or seller—is responsible for the maintenance of the marked-to-market margin.

BADLA System

EXAMPLE

Suppose you buy 1,000 shares of Infosys at Rs 3,500, your cash outflow is Rs 35 lakh. Instead of paying cash, you can ask your broker to find a borrower to finance your trade. This process of buying stocks with borrowed money is badla trading.

WORKING OF BADLA SYSTEM

The stock exchange acts as an intermediary between you and the actual lender.

You will be charged an interest rate for borrowing, which will be determined by the demand for that stock under badla trading

Thus, higher the demand for Infosys under badla trading higher will be the interest rate. You can keep your borrowing unpaid for a maximum of 70 days, after which you will have to repay the badla financier through the exchange

HISTORY OF BADLA TRADING

The Joint Parliamentary Committee on Irregularities in Securities and Banking Transactions, 1992 (JPC of 1992) discussed the irregularities of badla

SEBI issued a directive in December 1993 prohibiting the carry forward of transactions.

However it was recommended by the G.S PATEL COMMITTIE in the year 1995 and the carry forward transaction in the security market were permitted

It was further modified by the J.R VARMA COMMITTIE in the year 1997

a daily margin of 10 % was to be paid

50 % of which was to be paid in advance

forward trading limit was fixed for 20 crores

HISTORY OF BADLA TRADING

The NSE introduced futures contracts on the Nifty in the year 2000

Finally badla was banned in the year 2000-01

HISTORY OF BADLA TRADING

ADVANTAGES

1. In India there are restrictions on bank lending against shares. As a result, liquidity of the stock market is lower than in other countries. In such an environment Badla provides a system of financing share transactions and thereby promotes the flow of funds into the secondary market in shares.

2. The Badla system is more efficient in providing funds for share trading than the western system of bank lending against stocks.

ADVANTAGES

3. In the absence of both Badla and stock lending, the liquidity in the share market would be limited to those purchasing and selling for actual delivery. This means short term speculation will not be possible. The Badla system by enhancing speculative volume adds to the total volume in the market and thereby makes for better spot price discovery.

ADVANTAGES

DISADVANTAGES

1. While Badla allows speculation it does not perform the hedging function.

2. The Badla system lacks transparency. This made it susceptible to manipulation.

Comparison between badla and future

Badla Futures Expiration date unclear Expiration date known

Spot market and different expiration dates are mixed up

Spot market and different expiration dates all trade distinct from each other.

Identity of counterparty often known Clearing corpn. is counterpart

Counterparty risk present No counterparty risk

Badla financing is additional source of risk

No additional risk

Badla financing contains default-risk premia

Financing cost at close to riskless thanks to counterparty guarantee

Asymmetry between long and short Long and short are symmetric

Position can breakdown if borrowing/lending proves infeasible

You can hold till expiration date for sure, if you want to

THANK YOU !!