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January 18, 2000
COLUMNISTS
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Perils of badla financingMurali Iyer Do you think you really earn 20 per cent returns on badla financing all the time? Do you think that such a return is risk-free? The answer is no for both the questions. The truth is that badla is a complex system that contains many a pitfall for the uninitiated and the unwary. Investors need to be aware of the problems, especially when brokers on BSE and other regional stock exchanges are marketing vyaj badla schemes to their clients aggressively. Before you start believing in the stories of superlative returns (in excess of 20 per cent), coupled with liquidity, safety and flexibility, it is imperative that one takes a hard, rational look at the entire mechanism. This is so because financing badla is a definite no-no for the first-time investor in the stock market and also for those who don't have the time to constantly monitor the status of his/her investments and fluctuations in the market. Returns
And then the taxman cometh! Vyaj badla transactions are treated as purchase and sale of shares, thus getting subjected to capital gains tax of 30 per cent. Thus, your final returns get lopped off to that extent. Although naysayers might feel that vyaj badla provides an investor with an opportunity to maximise his earnings in a bull market, the fact remains that it is a good option for the experienced investor. Else, the nerve-wracking tension that accompanies stock market fluctuations may well take its toll. How does the system function?
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 outstandings. 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. In this case, let's assume the hawala rate to be Rs 69. If the financier wants to pay for 100 shares at 20 per cent per annum and the trade gets matched, the interest rate is converted into a weekly figure. In this case, it would be 0.38 per cent. On the hawala rate of Rs 69, this 0.38 per cent works out to 26 paise. The terminals would constantly keep flashing the best badla rate and the best annual yield for each stock on offer for a particular quantity. A constant fluctuation in these values during the two-and-a-half hour session is due to the constant change in demand and supply, and also market perception. The broker would give the financier a badla bill or informal contract note, which would have two entries. One would show a purchase of 100 shares at Rs 69 per share, while the other would show a sale of 100 shares at Rs 69.26 per share. The difference will be the financiers earning for that week. With the next trading cycle ending, the financier can either receive the difference or roll over his/her money to a new badla transaction. Who can participate?
Most brokers don't accept anything less than Rs 1 lakh per client for badla financing. And the stock selection too is at their discretion. But it would be prudent for you to know the basis of allocation of stocks to you, as you would be one among a lot of clients whose money has been collectively invested in vyaj badla. Badla rates vary between stocks, depending upon their demand and supply. These rates fluctuate considerably throughout the session. Ideally, brokers using the discretionary allocation of stocks to the badla account should pay a weighted average return to each client. This should be reflected in the badla bills. For getting the weighted average return on badla finance, it is advisable to look for brokers who have automated this process. As in any other market transaction, one cannot avoid brokerage in a vyaj badla transaction too. Brokerage for such deals could range between 1-2.5 per cent, trimming down your annual yield further. It is advisable to enter into a firm brokerage percentage prior to the commencement of the relationship. Are you safe?
In the recent history of BSE, there have been instances of brokers (having large carry-forward positions in highly speculative stocks) defaulting. Although these shares were enjoying very high badla rates at the time of the default, the prices had dipped sharply by the time the financiers got their shares. If the broker defaults, the financier is in a larger mess. Apart from the large institutional brokers, most brokers on BSE have a net worth of Rs 1-2 crore. Badla positions taken by them sometimes go up to 15-20 times their net worth. Even a 10 per cent downward shift in their position would wipe out the broker's entire net worth. And then you could bid goodbye to your money too. The BSE's Trade Guarantee Fund could be of some succour and solace in these situations, but just that. Failure to cash in on your interest gain at the end of the trading cycle gives the confidence to your broker to automatically roll over your investment to the next cycle. While opting out, always time your exit. By virtue of the exchange's settlement cycle, your money gets released within a ten-day period. This further reduces your yield. As in the case of defaults, the delay in the release of your money can be detrimental. So factor in those extra days while calculating your actual return. Although vyaj badla is considered to be an effective short-term instrument, as is the case with all such instruments, the delay can really eat into your returns. Given the quirks of the vyaj badla transactions and the inherent risks involved, it can be concluded that amateurs should stay away - it is strictly for the pro and the strong hearted. |
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