Stocks

zerodha: What’s protecting Indian stock market from severe crashes? Zerodha CEO Nithin Kamath answers

Had it not been for changing Sebi regulations that limit the amount of leverage that a trader can get from a stock broker, the downfall seen in the Indian stock market this year could have been much more, warns Zerodha CEO Nithin Kamath. “When there is less leverage in the market, it creates less froth on the upside and less fear on the downside,” says India’s No. 1 stock broker while crediting the change in regulatory guidelines in making the downside less severe on Dalal Street. Edited excerpts :

How important do you think are Sebi regulations on limiting leverage in strengthening the domestic equity market? Is it true that the recent downfall in Nifty was less because we were less leveraged?
In the stock market, you climb the stairs while going up and while coming down you jump down the building. That’s how the markets move. If it takes you six years to go from 100 to 200, it can potentially do 200 to 100 in five days.

When markets fall, the first 5-10% is usually okay, but when the drawdown is more then the leverage starts forced unwinding. The intensity of the fall magnifies because the guys who are leveraged will either have to bring in their mark-to-market losses or square off their positions.

Smart Talk



And when the markets are in a bearish phase, people squaring off positions creates a really large impact. That’s what happened in the US from March to June this year. The last bit of the fall was leverage being unwound really fast.

In India, we did not have that problem this year because there was hardly any leverage – be it at the customer level, broker level or at the entire industry level. There were hardly any forced leverage square offs, which meant that when other markets fell we fell less. And as it bounced back, we are almost close to all-time highs.

« Back to recommendation stories



When there is less leverage in the market, it creates less froth on the upside and less fear on the downside.

So how have the rules changed over the years? How easy was it earlier to get leverage?
Until 2010 or so, it was essentially almost unlimited leverage. Based on his judgement the stock broker could allow you to buy as much as you want. For example, with Rs 1 lakh you could be allowed to buy for Rs 1 crore as long as the broker is okay with the risk.

Today the broker cannot even fund customers beyond 60-70%. If you buy Rs 1 lakh worth of shares of

using margin funding you need to have at least Rs 20,000 with you. The maximum leverage you get is five times.

One of the main reasons for the 2008 crash was leverage unwinding. Brokers gave high leverage because they could make money in two ways – if you buy stuff for Rs 1 crore with Rs 1 lakh your brokerage fee is on Rs 1 crore and not on Rs 1 lakh. The second was brokers could also charge interest on the money lent. Besides, the broker also did not have to bring his own capital because they could lend one customer’s money to another customer. It was a very risky proposition of sorts.

Today, the maximum leverage is five times, the broker has to fund from his own capital and you cannot use one customer’s fund for another customer. The regulations have changed drastically in the last few years.

In fact, Sebi regulations were one of the enablers in starting Zerodha 12 years ago. Until 2011-2012, a stock broker could allow customers to take F&O positions without any money upfront either for intraday or for overnight trades. We knew that regulatory changes were on its way and that is how we started Zerodha because we did not want to compete with other brokers on leverage.

The ferocity of the regulatory changes in the last 2-3 years has been quite crazy.

If you look at the historical data of the last five years, you can see that India has become less volatile than the US. Probably, most of it is due to the impact of India being less leveraged.

When it comes to leverage, how does it work in the US market? Are our rules much more stringent?
It is like a wild west there. You can potentially do whatever you want. Firstly, it is not easy to become a broker and it is also not very easy to commit financial frauds as the penalties are significant.

In India, the broking industry has the baggage of a few rotten apples spoiling it for everyone. In the US the broking lobby is really powerful, so making any regulatory changes is very hard. In India there is not a strong broking lobby and so if there are any regulatory changes happening there is no real opposition.

In the US most of the brokers almost act like banks. They can use one customer’s money to fund another customer or for their own working capital requirements.

In India if a customer does not use his money, we have to send the money back to the customer’s bank account. In the US, most of the brokers open a margin account by default which means that when you buy the stock, it does not sit in your demat account like in India. It sits in the broker’s name. The broker can now even leverage the stocks that you have sitting with them.

When seen from India, the US seems like a wild west but because you cannot get away with financial crimes very easily so you do not see too many incidents even though there is so much flexibility of sorts.


Source link

Leave a Reply

Your email address will not be published.

Back to top button