Badla (stock trading)
Encyclopedia
Badla was an indigenous carry-forward
system invented on the Bombay Stock Exchange
as a solution to the perpetual lack of liquidity
in the secondary market
. Badla were banned by the Securities and Exchange Board of India
or SEBI
in 1993 (effective March 1994), amid complaints from foreign investors
, with the expectation that it would be replaced by a futures
-and-option
s exchange. Such an exchange was not established and badla were legalized again in 1996 (with a carry-forward limit of Rs
20 crore
per broker) and banned again on July 2, 2001, following the introduction of futures contracts in 2000.
Badla trading involved buying
stock
s with borrowed money
with the stock exchange
acting as an intermediary
at an interest rate
determined by the demand
for the underlying stock and a maturity
not greater than 70 days. Like a traditional futures contract
, badla is a form of leverage
; unlike futures, the broker—not the buyer or seller—is responsible for the maintenance of the marked-to-market margin.
The mechanism of badla finance can be explained as follows:
Suppose A has to buy 100 shares of a company at Rs 50 each. But he doesn't has enough money now. But the value of shares is very less now, so in order to buy the shares at current prices, A can do a badla transaction. Now there is a badla financier B who has enough money to purchase the shares, so on A's request, B purchases the shares and gives the money to his broker. The broker gives the money to exchange and the shares are transferred to B. But the exchange keeps the shares with itself on behalf of B. Now, say one month later, when A has enough money, he gives this money to B and takes the shares. The money that A gives to B is slightly higher than the total value of the shares. This difference between the two values is the interest as badla finance is treated as a loan from B to A. The rate of interest is decided by the exchange and it changes from time to time.
Forward contract
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a...
system invented on the Bombay Stock Exchange
Bombay Stock Exchange
The Bombay Stock Exchange is a stock exchange located on Dalal Street, Mumbai and is the oldest stock exchange in Asia. The equity market capitalization of the companies listed on the BSE was 1.63 trillion as of December 2010, making it the 4th largest stock exchange in Asia and the 8th largest...
as a solution to the perpetual lack of liquidity
Market liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
in the secondary market
Secondary market
The page applies to the finanical term; For the merchandising concept, see Aftermarket .The secondary market, also called aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold....
. Badla were banned by the Securities and Exchange Board of India
Securities and Exchange Board of India
The Securities and Exchange Board of India is the regulator for the securities market in India.-History:It was formed officially by the Government of India in 1992 with SEBI Act 1992 being passed by the Indian Parliament...
or SEBI
Securities and Exchange Board of India
The Securities and Exchange Board of India is the regulator for the securities market in India.-History:It was formed officially by the Government of India in 1992 with SEBI Act 1992 being passed by the Indian Parliament...
in 1993 (effective March 1994), amid complaints from foreign investors
Foreign direct investment
Foreign direct investment or foreign investment refers to the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor.. It is the sum of equity capital,other long-term capital, and short-term capital as shown in...
, with the expectation that it would be replaced by a futures
Futures exchange
A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. These types of...
-and-option
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
s exchange. Such an exchange was not established and badla were legalized again in 1996 (with a carry-forward limit of Rs
Rupee
The rupee is the common name for the monetary unit of account in India, Sri Lanka, Nepal, Pakistan, Mauritius, Seychelles, Maldives, and formerly in Burma, and Afghanistan. Historically, the first currency called "rupee" was introduced in the 16th century...
20 crore
Crore
A crore is a unit in the Indian number system equal to ten million , or 100 lakhs. It is widely used in India, Bangladesh, Nepal, and Pakistan....
per broker) and banned again on July 2, 2001, following the introduction of futures contracts in 2000.
Badla trading involved buying
Trade
Trade is the transfer of ownership of goods and services from one person or entity to another. Trade is sometimes loosely called commerce or financial transaction or barter. A network that allows trade is called a market. The original form of trade was barter, the direct exchange of goods and...
stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
s with borrowed money
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
with the stock exchange
Stock exchange
A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and...
acting as an intermediary
Financial intermediary
Financial intermediation consists of “channeling funds between surplus and deficit agents”. A financial intermediary is a financial institution that connects surplus and deficit agents...
at an interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
determined by the demand
Demand
- Economics :*Demand , the desire to own something and the ability to pay for it*Demand curve, a graphic representation of a demand schedule*Demand deposit, the money in checking accounts...
for the underlying stock and a maturity
Maturity (finance)
In finance, maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal is due to be paid....
not greater than 70 days. Like a traditional futures contract
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...
, badla is a form of leverage
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
; unlike futures, the broker—not the buyer or seller—is responsible for the maintenance of the marked-to-market margin.
The mechanism of badla finance can be explained as follows:
Suppose A has to buy 100 shares of a company at Rs 50 each. But he doesn't has enough money now. But the value of shares is very less now, so in order to buy the shares at current prices, A can do a badla transaction. Now there is a badla financier B who has enough money to purchase the shares, so on A's request, B purchases the shares and gives the money to his broker. The broker gives the money to exchange and the shares are transferred to B. But the exchange keeps the shares with itself on behalf of B. Now, say one month later, when A has enough money, he gives this money to B and takes the shares. The money that A gives to B is slightly higher than the total value of the shares. This difference between the two values is the interest as badla finance is treated as a loan from B to A. The rate of interest is decided by the exchange and it changes from time to time.