Presentation on BADLA SYSTEM

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

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

 The NSE introduced futures contracts on the Nifty in the year 2000 Finally badla was banned in the year 2000-01

Comparission between badla and future

Badla
Expiration date unclear

Futures
Expiration date known

Spot market and different expiration dates are Spot market and different expiration dates mixed up all trade distinct from each other. Identity of counterparty often known Counterparty risk present Clearing corpn. is counterpart No counterparty risk

Badla financing is additional source of risk

Badla financing contains default-risk premia Asymmetry between long and short Position can breakdown if borrowing/lending proves infeasible

No additional risk
Financing cost at close to riskless thanks to counterparty guarantee Long and short are symmetric You can hold till expiration date for sure, if you want to