Kamath warns, trend of borrowing for share trading will sink:Neither investors nor brokers can exit when circuit limits hit mid, small cap stocks

The use of Margin Trading Facility (MTF) in the country’s stock market is rapidly increasing these days. Zerodha co-founder Nitin Kamath has issued a serious warning about this pace. He says that MTF appears to be an easy earning source for brokers, but if even one bad day comes and risk management fails, all earnings can be wiped out in one stroke. Not only this, it can impact the entire financial system. Kamath stated in a social media post on Tuesday that brokers’ MTF books are growing, while the market is neither going up nor down. This imbalance is dangerous. Comparing it with South Korea, he said that their stock market has risen about 150% in a year, so people are borrowing to take advantage of that surge. India’s situation is different. Here the market is stable, but MTF is increasing, which is a dangerous sign. Explaining the biggest risk of MTF, Kamath said that if there is a heavy fall in any stock and it crashes more than the margin (such as more than 20%), then the broker has to bear the loss. Recovering losses from customers is often difficult. The matter becomes serious when a customer pledges a share and increases investment in the same. When circuits are applied on mid and small cap shares, neither the investor can exit, nor the broker. Kamath stated that approximately 50% of the entire brokerage industry’s MTF book is in those shares which are not in the FO (futures) segment. That is, where there is no hedging option. Kamath warned that some brokers’ MTF book can reach up to 500% of their net worth (total assets). If there is a sudden major fall in the market, such brokers can get stuck in those MTF positions from which it will not be possible to exit. Kamath also said that under competitive pressure, collateral margin may soon have to be permitted for MTF purchases, which is currently prohibited. If this happens, the risk will increase further. What is MTF? MTF, or Margin Trading Facility, is a facility in which an investor can buy shares by borrowing from a broker. The investor puts in some money themselves, and the broker provides the rest. If there’s a profit, the investor gets more returns, but in case of loss, the broker may also have to bear the loss. If there’s a sharp fall in the share and a circuit breaker is triggered, neither the investor can exit nor the broker. This is the ‘one bad day’ that Kamath has warned about. ​