Badla System

What is Badla
 Badla, in common parlance, is the Carry-Forward
system which means getting something in return.
 It is the charge which the investor pays for carrying
forward his position. This hedge tool lets the investor
take a position in a scrip without actually taking
delivery of the stock, thus carrying forward his
position on the payment of small margin.
 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.
 Example: Suppose A has to buy 100 shares of a company at Rs 50
each. But he doesn't has enough money now. But the value of
shares is very less now, so in order to buy the shares at current
prices, A can do a badla transaction. Now there is a badla financier
B who has enough money to purchase the shares, so on A's request,
B purchases the shares and gives the money to his broker. The
broker gives the money to exchange and the shares are transferred
to B. But the exchange keeps the shares with itself on behalf of B.
Now, say one month later, when A has enough money, he gives this
money to B and takes the shares. The money that A gives to B is
slightly higher than the total value of the shares. This difference
between the two values is the interest as badla finance is treated as
a loan from B to A. The rate of interest is decided by the exchange
and it changes from time to time.
 How Badla System Works
 Assume that there have been 12 trades of 100 shares each in "ABC"
stock, and there are 12 separate buyers and sellers respectively.
Among the buyers, while six want to carry forward their positions,
six want to take delivery. Of the sellers, eight wish to deliver the
shares while four are keen on carrying their positions forward. Now
six buyers make the payment for their purchases, while eight sellers
effect delivery. Six buyers and six sellers get squared off. Four
"buy" carry-forward positions get matched against four "sell" carry-
forward positions.
 To ensure payment to the remaining two sellers for their 200
shares, Vyaj badla financiers come in. This financier charges
interest (badla) for the money paid on behalf of the two buyers for
them. The demand and supply of funds and shares determine this
rate. Shares delivered by the seller are kept by the exchange in the
clearing-house and allocated to the financier's broker in a special
account, forming the financier's collateral.
 On the BSE, brokers who are sure of taking or making delivery of
shares mark their respective "for delivery" positions. This helps the
exchange to arrive at the net outstanding positions on Friday
evening (the last day of the settlement on BSE), by deducting them
from the broker's weekly outstanding. The difference is thrown
open to the market's badla trading session on Saturday. Nowadays,
the entire session is automated and is conducted on the trading
screens of the brokers.
 Prior to the commencement of this session, the base price (hawala
rate) is fixed, which is normally the closing price of the scrip on
Friday. An outstanding "buy" position in a stock sees a "seedha
badla" where the financiers participate. An outstanding "sell"
position in the stock sees an "ulta" or "undha badla" where the
stock lenders participate. Specified quantities of the stock on offer
are bought and sold at the financier's desired interest rate -
the badla rate
 Criticism
 The criticism against the badla system has essentially been on two
counts: equity and transparency.
 The system was slanted in favor of short sellers who could, in a
normal market situation, earn interest even without owning the
shares sold (it has been argued though, that such short selling helps
to check speculative and furious buying). Also, it was suspected
that the contango and backwardation charges reportedly decided at
the badla sessions were often untrue. Besides, it appears that the
limit of 70 days within which the carryovers were to be settled, was
often exceeded.
 Beside this, Badla system fell into disrepute because of its faulty
implementation and lack of proper monitoring by concerned stock
exchange authorities. Particularly, the margins collected were low,
allowing excess leveraged trading and not having proper
monitoring and surveillance.
 Reintroduction of Badla
 Some features of the new system of CARRY FORWARD (CF),
introduced at the Bombay Stock Exchange in January 1996, were:
 Sale or purchase of transactions may be carried forward up to 75
days.
 Brokers are to classify the transactions, as to whether for delivery
or CF, and report daily.
 Badla sessions will be screen-based.
 Strict monitoring of brokers’ positions with the imposition of
various margins: daily, mark-to-market and CF.
 Final Ban on Badla
 Concerted lobbying by the BSE, the feudal badla system was
discontinued into 2000. The reason for the intense lobby is not
hard to find - a quick glance at the table shows that the average
BSE broker, in the first four months of 2000, has already made
about Rs. 10 crores in excess thanks-to-badla profits. Even in a bad
year like 1998, excess per broker profits were about Rs. 8 crores.
In 1999, each of the top 50 BSE brokers made about Rs. 1.1 crores
in badla commissions alone, and more than Rs. 100 crore each in
excess badla profits.
 How Derivatives Different From Badla
 Badla is closer to being a facility for borrowing and lending of shares and
funds. Borrowing and lending of shares is a functionality which is part of
the cash market. The borrower of shares pays a fee for the borrowing.
When badla works without a strong margining system, it generates
counterparty risk, the evidence of which is the numerous payments crises
which were seen in India. Options are obviously not at all like badla.
Futures, in contrast, may seem to be like badla to some. Some of the key
differences may be summarized here. Futures markets avoid variability of
badla financing charges. Futures markets trade distinctly from the cash
market so that each futures prices and cash prices are different things (in
contrast with badla, where the cash market and all futures prices are
mixed up in one price). Futures markets lack counterparty risk through
the institution of the clearinghouse which guarantees the trade coupled
with margining, and this elimination of risk eliminates the risk premium"
that is embedded inside badla financing charges, thus reducing the
financing cost implicit inside a futures price.
 Badla And Futures
Badla Futures

Expiration date unclear Expiration date known

Spot market and different expiration dates are Spot market and different expiration dates all
mixed up trade distinct from each other

Identity of counterparty often known Clearing corporation is counterpart

Counterparty risk present No counterparty risk

Badla financing is additional source of risk No additional risk

Asymmetry between long and short Long and short are symmetric

Position can breakdown if borrowing/lending proves You can hold till expiration date for sure, if you want
infeasible. to
Thank You