Succour for the markets at last?

Mumbai: Finally it is happening. The joint technical committee on bank financing of equities, set up by the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi), on 18 September has allowed banks to finance margin trading in shares. Provided the banks restrict their advances within the 5 per cent of their total advances, which is currently their exposure limit to the capital markets.

The move is expected to provide the much-needed liquidity to the beleaguered stock markets, which go through a rough phase in the last ten days following the terrorist attacks in the US with the Sensex touching an eight-year-low. Indian stock markets have suffered from lack of liquidity ever since the age-old badla system was banned with effect from 2 July 2001.

Though Sebi had introduced options and futures trading from the same date, it has remained restricted to index futures and only to some specific stocks, thereby failing to provide alternate liquidity to the markets. Readers may recall that domain-B had reported on 17 September that margin trading, if introduced, would go a long way in improving the sentiment and give a boost to the markets.

The only hurdle in margin trading getting under way is the guideline, which the RBI is likely to announce by the end of this month. The guidelines will be valid for a period of 60 days from the date of implementation and will be reviewed thereafter.

The markets had already got the wind of what was in store on 18 September itself and reacting positively to the likelihood of margin trading coming in, the Sensex bounced back 3.79 per cent, or by 101.49 points, by the time trading ended on the same day. The positive incline continues on 19 September and the Sensex is up about 16.17 points at 2798.64.

Speaking to domain-B, HDFC Bank head (equities and private banking group) Abhay Aima said: Margin trading will provide the much-needed liquidity to the system. But a lot will depend on the guidelines to be announced by the RBI.

What is margin trading? It is a very popular system, or product, followed widely in developed countries such as the US and the UK. This facility allows investors to buy shares without having the entire money required to pick up delivery. But they are required to possess at least 40 per cent of the total purchases, with the balance coming from the banks.

For example, if the total purchase consideration amounts to Rs 1 lakh, an investor will be required to put in Rs 40,000 and the balance Rs 60,000 could be borrowed from the bank. The bank will keep the shares and in case the value of the concerned scrip falls, the investor will be required to replenish the difference. If the replenishment does not happen, banks will be entitled to sell the shares and recover the money advanced or the margin.

The system will cover 53 scrips initially, forming a part of the NSE-Nifty and the BSE-Sensex. Essentially a leveraging system, margin trading will allow flow of a lot of funds and encourage speculative buying.

The all-important question is will the banks bite, having gone through a harrowing experience in the last scam? The general feeling is that in case a special purpose vehicle is created for this, the banks will be interested. In that case, the SPV will be then responsible for collecting shares and paying off. And the banks role will be restricted to that of a provider.

Says Aima: The SPV, if created, will act like an independent body. For the first time speculation is being recognised as a legitimate activity and is being instituionalised, which is a good sign. He feels the product should be made to include individuals as well.

Sources have said most of the private sector banks have already exhausted their 5 per cent limits, but the public sector banks are yet to do so. Hence lots of funds could get pumped into the markets once the system gets under way.