A local brokerage house, round the corner. A big client calls up and orders the dealer to buy 20,000 shares of ITC and instructs him to keep it in ‘Badla’ (?)
A leading stock operator with a big position in one scrip is busy ramping the price on Friday to ‘chchapo’ a good ‘Hawala’ rate for his ‘Badla’ (??)
The head of treasury of a finance company has put up a proposal to the CEO to get a clearance to place his short-term fund surplus in ‘Badla’ (???)
A smart trader, noticing that ‘Badla’ rates have increased in the last two weeks while the market has gone nowhere, decides to sell his long positions and put his money in ‘Badla’’(????)
A leading pink newspaper’s bold headlines read: ...The ‘Badla’ positions are huge and the market is likely to fall... (?????)
The Taj Conference room is hosting a symposium on equity futures. A doyen of Indian equity markets is speaking on ‘Badla vs Futures’ (??????)
‘Badla’...a five-letter word that means six different things to six different people. And we all thought it was what Big B did to the villains who killed his parents in ‘Coolie’! We checked with an expert on the subject...
Settlement mechanism
The existing settlement mechanism on the BSE is a fixed 5-day settlement period that begins on Monday and ends on Friday. The trades for these five days are aggregated and the net positions at the end of the session are settled. The participants for any session can be classified into three categories:
- the investors, who buy stocks clearly with the intention of picking up delivery of shares by paying for their purchase;
- the traders, who use the session as a 5-day futures market and square off transactions within the settlement; and,
- the traders who desire to pick up delivery but are not capable of funding the transaction.
Capital unrestrained
What does a trader who does not have the money do to fund his transactions? Simple answer—borrow. But how? Borrowing is not simple as the individual’s credit rating will have to be assessed. Some people will have access to cheaper money because of some clout, whereas the rest will get it at exorbitant rates. But the lenders are likely to insist on a fixed tenure for the loan and steep penal rates for pre-payment. The trader (borrower) runs the risk of borrowing for a fixed term to fund equities that are very volatile (we all know the 2-days’ upper circuit and 3-days’ down circuit routine very well, don’t we?).
Enter the leveler
The ‘Badla session’ is a mechanism that is set up exclusively to offset outstanding transactions at the end of the settlement. It ensures that the borrowing rates (‘Badla’) are market-determined and, hence, fair to all the participants. The exchange stands between the lender and the borrower, thereby mitigating the individual credit risk.
The ‘badla session’ in its original form was envisaged as a borrowing mechanism at a rate determined by the market. This happens in a situation when the cash starved traders outnumber traders who do not possess the stock they have sold in terms of value (net long position). However, sometimes the ‘badla’ session also functions as a ‘stock lending’ mechanism. This event occurs when the traders who do not have the stock outnumber the cash-starved traders (net short position). The lacunae in the system is that it functions at the aggregate level. As a result, a person might have short sold a stock but since the market position is net long, he will be paid ‘badla’ while carrying forward his short position. However, whenever the market position is net short sold, short sellers end up paying while the net long position holders make merry. The charge paid by short sellers is called ‘Undha Badla’...
(It was a mistake to have asked an expert about this subject. Half the stuff went over our heads. Let us check with a dealer...their explanations are far more lucid and practical)
Traders in need
Let us assume that Harshad buys 10,000 shares of ITC @ Rs950 per share. After all the innumerable trades during the week, he is still left with this position. Harshad Bhai does not have money but desires to carry forward his transaction as he knows (!) that the company will announce a bonus next week and the stock will fly. Therefore, he instructs his broker—‘Borrowmore’—to put it in the ‘Badla session’.
The provider
Munshiji is a rich merchant with a lot of surplus funds as he pays his suppliers 15 days after his customers pay him! He detests trading or investing in equities as he believes that traders like Harshad Bhai have reduced it to a gambling den. He dreads losing his (?) capital, but the lucrative yields in Badla are too attractive to ignore. He instructs his broker—‘Avenger’—to put his funds in badla.
Meeting ground
Friday’s close of ITC was Rs1001, so the Hawala rate for Saturday’s badla session has been rounded off to Rs1000. Borrowmore puts Harshad Bhai’s quote as 10,000 shares to offer @ Rs5 per share (the badla charge) along with the many other quotes for his other clients. At the same time, Avenger is scanning the screen looking for a good deal for Munshiji. He spots the Rs5 quote and hits it, without knowing that it is Harshad Bhai’s quote...had he known, he would have countered the quote at Rs6 per share! He doesn’t care as he is not lending to Harshad Bhai directly but to the exchange, which acts as a counter-party for each transaction.
Satisfaction guaranteed
As a result of this trade, Harshad Bhai has been able to offset his transaction for this settlement at Rs1000 per share (the Hawala rate) while opening a new buy position starting Monday @ Rs1005 per share. In the process, he has paid Rs5 per share (the difference) but has ensured that he still benefited by ramping the price on Friday to 1,000 so as to improve his cash flow at least for the settlement (remember, his price was Rs950, so he still takes in Rs50 for the settlement! Next settlement, he may have to cough up but then tomorrow is another day! Ha! Ha!). Munshiji is also all smiles as he pockets the Rs5 per share for helping to shift positions for one settlement, one week—an yield of 0.5% per week or 26% annualised. For a similar risk profile, he would have got 0.2% per week or 11% annualised! He has reason to feel happy.
(Bahut hogaya! Next time we will find out more about how those analysts and traders use these badla positions and badla rates to figure out short-term market trends. Then of course, there is a whole new gamut of issues—economic functions of badla, regulatory issues (taming greed) and Badla vs Futures!! We thought it was a simple thing, but it is a book in itself! More of all this soon. Let us digest all this lest we suffer a bout of indigestion!)
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