The badla system revisited

Abstract

This paper is an attempt to examine the issues underlying the current debate about reintroducing the badla system. The differences between badla system on one hand and options and futures markets on the other are highlighted. Then it is argued that for an efficient security market, facility of buying stocks on margin and facility to sell short is a must. In the absence of an acceptable central depository system and due to cumbersome procedure of share transfers, badla system is the most appropriate settlement system under Indian conditions to meet the demands of a strong and efficient security market. Badla system in the past fell in disrepute mainly because of a faulty implementation and monitoring system. There were frequent payment crises and settlement delays. Stock Exchange were functioning as closed clubs of brokers ignoring general interests of investing public. With the change in power equation between Executive Director and the member brokers on the one hand and composition of the Governing Board of Stock Exchanges on the other, it can be hoped that necessary control and monitoring system for successful operation of badla system would be strictly adhered to. Two things would need to be ensured. a) No compromise in fixing havala rates. These rates must reflect the current market price at the end of the trading period. Correct havala rates would facilitate marking to the market of carry over business, and thus reduce the settlement risk in the ensuing period. b) Collection of full margins on the entire carry over business (on gross basis). The margin percentage should be sufficiently high (say, 35 percent of havala rate) so as to act as a deterrent to high speculation (so called bubble trading) and be adequate for guaranteeing the performance of the contract in the ensuing settlement. The author also argues that SEBI s insistence that carried over transactions not be squared off but must be settled by delivery and payment within 90 days is impractical and ill-advised. One must realize that our trading system is very different from the one prevalent in other countries, and it is impossible to identify transaction-wise carry over business in our trading system.