Badla System

THE BADLA SYSTEM

Introduction

When a bull market is gaining hold and when shares prices are expected to reach dizzying heights, the one common refrain among the small investors is the lack of alternatives for multiplying returns through leveraging one's investment. The question often arises when one has the capacity and standing to mobilize funds for investing in the market and one is looking for a systematic investment

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We have heard of "options", "futures", and the even more exotic "derivatives", all of which help in increasing one's returns many times over - if used correctly. The sophisticated derivatives which are in existence abroad developed from the commodity markets there. In India, sophisticated financing techniques existed in our commodity markets for centuries, long before the concept of options came into existence abroad.

With the beginning of the stock markets, many of these techniques which closely approximated options and futures came into our financial markets and the even more exotic "derivatives" thrived till they were banned in the '60s. One relic from those times still exists - the much maligned but still useful - badla financing. Badla can be useful for an active investor if he wishes to leverage on his investments thereby multiplying his returns.

The concept of Badla:

Badla, in common parlance, is the Carry-Forward system which means getting something in return. The badla system of transactions has been in practice for several decades in the Stock Exchange, Mumbai. The badla system serves an important need of the stock market. If an investor feels that the price of a particular share is expected to go up or down, without giving or taking the delivery he can participate in the possible fluctuation of the share. Financing in Badla, in effect, has two aspects to it, namely

1. Seedha badla or Vyaj badla- Here the financiers participate

2. Undha badla - Here the stock lenders participate.

What is Badla?

In the badla system, a position is carried forward, be it a short sale or a long purchase. In the event of a long purchase, the market player may want to carry forward the transaction to the next settlement cycle and for doing this he has to compensate the other party in the contract .The 'seedha badla' financier enters into the system to lend money to the market player for a return. This is measured as interest on the funds made available for one settlement cycle, i.e. one week or a longer period in case of book closure badla system. Similarly 'undha badla' or contango charges are returns paid by the stock borrower to the stock lender. In a short sale, when the market player wants to carry forward the transaction to the next settlement cycle, he has to borrow the stocks to compensate the other party in the contract. The charge paid on the borrowed stock is called contango charges.

How is Baadla done ?

On every Saturday in the Stock Exchange, Mumbai, a badla session is held. The scrip in which there are outstanding positions is listed along with the quantities outstanding. Depending on the demand and supply of money, the carry forward rates are determined. If the market is over bought, the demand for funds is more and the badla rates tend to be high. However, when the market is oversold , the badla rates are low or even reverse i.e. there is a demand for stocks and the person who is ready to lend stocks gets a return for the same. This is known as the undha badla.

We can use an example to illustrate the concept of badla trading. You have purchased 100 shares of INFOSYS for Rs 7000, which is trading at Rs 7180 in the market at the end of the trading session which runs from Monday to Friday in BSE. You feel that the stock price will rise further. Therefore you wish to carry the contract forward to the next trading session by paying what are called badla charges.

In any badla transaction there are two key elements, the hawala rate and the badla charge for the scrip. The badla charge is the interest payable by the investor for carrying forward the position. The badla charge, as explained earlier, is market determined and primarily dependent on the supply of funds for financing a share. It is fixed individually for each scrip by the exchange every Saturday and it is calculated on what is called the hawala rate.The hawala rate is the price at which a share is squared up in the current settlement and carried forward into the next settlement in the next trading