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.

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" carryforward 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

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.

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.

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.

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 Expiration date unclear

Futures Expiration date known

Spot market and different expiration dates are mixed up

Identity of counterparty often known Counterparty risk present Badla financing is additional source of risk Asymmetry between long and short

Spot market and different expiration dates all trade distinct from each other
Clearing corporation is counterpart No counterparty risk No additional risk 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