Investors should be cautious of margin trading as costs go up

Given the rising cost, one has to remain cautious as margin trade funding comes with inherent risk, and one should trim margin leverage, overall exposure
Investors should be cautious of margin trading as costs go up

MUMBAI: The second-best rally that the market notched up in the year to March 2024 in the past five fiscals—with both the indices ratcheting up 25% on-year gains—also has set another all-time record in a not- so-popular market segment—the margin trade funding (MTF) book of brokerages.

The MTF book of brokerages made an astronomical growth from R7,100 crore in early February 2020 to a tad over R 57,100 crore this March. For the Sensex, FY21 was the best rally zooming 68%, making the investors richer by tens of trillions with the market cap now sniffing at the $5-trillion-mark. From the pandemic lows of March-April 2020, the indices have rallied a full 187% by this March. The MTF books of the brokerage industry have more than doubled from around R 26,000 crore in March 2023 to over R57,100 crore this March, or have made an astronomical growth from a meagre R7,100 crore in February 2020, according to Icra Ratings.

Higher margin funding costs

Such a massive jump in a short span of four years has both brokers as well as investors laughing their way to their banks. Borrowers, who are the investors here, were being charged only 12-14% as monthly interest on the amount they borrowed from their brokerages as margin funding so far. But that’s history now. Brokers will not just walk faster but run to their banks because the pricing has been raised by more than a third of percentage point from this month to 18-20%.

For investors though, given the looming poll-related uncertainties and the resultant volatility in the market, along with the double whammy of higher interest outgoes, their profit-making jaunt will be a lot longer and tedious. Though no brokerage has come out on record officially disclosing their new pricing, many admit to doing so already or are in the process of doing so, whacking it up to 18-20%.

Industry insiders ascribe two reasons for this. First, the reported regulatory tightening wherein the Reserve Bank has nudged non-banking lenders, who are the primary source of MTF, to raise their funding cost to brokers as it fears a bubble in the making due to the MTF-led over leverage. As a result, the borrowing cost for brokerages have gone up by 200-300 bps to 11% or more of late.

The second trigger is that non-banks on their own have raised the cost of such funds fearing rising volatility in a highly vile poll season as part of their own internal risk tightening, which in turn was spawned by the recent RBI ban on JM Financial and IIFL from lending against shares.

About margin trade funding

For the uninitiated, margin trade funding is a facility wherein an investor pays only 25-35%— at the upper end and the lower end this can be as high 5-8x of own funds—of the value of the stock one buys and the rest is paid for by brokerage for a monthly interest of 12-14%.

This means that brokerage can allow you to own 65% or up to 800% more of the same stock over your own investment. Brokerages either have their own NBFCs or borrow from banks or other sources even from debt market instruments to help investors this way.

This 30-35% own fund demand is normally from bank-led full-service brokerages such as HDFC Securities, which is the leader in this market with a loan book of close to R10,000 crore, ICICI and Kotak among others, but standalone players like IIFL, Edelweiss, JM, Motilal etc offer much higher leverage to the tune of 5-8x your own fund on a day when the market is on a song. This margin percentage made available to a customer is mostly based on a dynamic calculation method depending on the type of stock one buys—large caps/index stocks like those constituting the Sensex and the Nifty or mid and small caps.

While HDFC offers the longest MTF facility running into 275 trading days, which means more than a calendar year of credit and thus you can own the stocks for those many days—no wonder why it leads the market in outstanding loan—others mostly offer only up to 30 days or even less. On the other hand, discount brokers like Zerodha or Upstox and their other peers aren’t into the MTF street.

All that an investor has to do is to electronically pledge the shares bought on margin funding the next day or when you get an email from the depositories (CDSL or NSDL) failing which your brokerage has the legal powers to square off the shares which is done by the respective risk departments by around 2.30 pm.

The next step is to maintain the required margin, which also includes the daily interest you owe to your brokerage, in the bank account linked to your demat account failing which again the risk will square off the position by pre-noon trade session. But the whole exercise is going to pinch the debt funded investor now as the rates have been raised massively.

Bank brokers, supported by their competitiveness in money market borrowings both in terms of size of borrowings as well as rates, are the dominant players in the MTF space with close to 65% of the volume, according to this agency.

Given the rising cost coupled with market volatility due to the poll outcome uncertainties, an investor will be better served by being cautious and trimming her margin leverage and the overall market exposure.

Know your risks

  • The margin percentage is mostly based on a dynamic calculation method

  • An investor has to electronically pledge the shares bought on margin funding the next day

  • He/she has to maintain the required margin, which also includes the daily interest one owes to the brokerage

  • An investor will be better served by being cautious

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