Badla system: a reappraisal

Abstract

The badla system, which allowed transactions to be carried forward from one trading valan to the next, was banned by the SEBI in March 1994. SEBI was hoping that for the purpose of speculative trading, an internationally accepted system of options and index future trading would replace the indigenously evolved badla system. To call badla trading a kind of forward trading is misleading. Badla is carryover of a transaction and not a forward transaction. While derivative trading (i.e. futures and options trading) is a trading in future risk among different participants in the stock market, mostly used as a hedging device. To have a strong cash market with sufficient liquidity, some element of leveraged (i.e. speculative) trading is necessary. Now this is possible only if the system provides: a) facility to buy shares on margin, and b) facility to sell short. 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. With proper framing of rules and regulations, chances of its misuse would be reduced considerably; without incurring large efficiency losses associated with financial regulations. These costs associated with financial regulations include both the direct element (the compliance cost ) and the indirect element (i.e. the damage inflicted on the competitiveness, dynamism and innovativeness of the system, the possible reduction in investor choice, the distortions included in market behaviour and business practice etc). Further, regulatory framework should also ensure competitive neutrality among different participants on the stock exchanges. SEBI reconsidered its decision and badla was reintroduced in July 1995 with severe conditions. In this paper, these conditions are critically evaluated. A few modifications are suggested. 1. not to insist on segregation of transactions at the time of trading. 2. not to insist on separate identification of each transaction with an audit trail and limit of 90 days for completion of transaction. 3. not to impound profits and streamline the daily and carryover margin requirements. 4. Financiers not to trade on securities but allowed to hold securities with them. Suggested changes would make the system cost effective, less complex, easy to implement, and will ensure level playing field among different market participants.