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Understanding Badla

Murali Iyer

In the context of managing money, more specifically related to the stock markets, the term "badla" holds a wholly different analogy. The stock markets have held a great fascination for a lot of people. The volatile swings in various scrips sets the adrenaline pumping, like nothing ever has for them. These stocks are divided into 'A', 'B1', 'B2' and 'Z' group on the Bombay Stock Exchange (BSE). The most liquid and heavily in-demand shares comprise the 'A' group (150 on the last count). The top 30 scrips from this hallowed category form the BSE Sensex, the pure market index. This group is also known as the 'forward' group, as the carry-forward system is allowed to provide more depth to the market. If the uninitiated is scratching his / her head, let me explain. Although you can buy or sell stocks in this group, you need not take or give physical delivery of the shares. Badla comes to your rescue here.

Badla or the modified carry-forward system is a time-tested one and is used in the stock exchanges at Mumbai, Delhi, Kolkata and Ahmedabad. Now, the proposed Interconnected Stock Exchange of India Ltd (ISE), promoted by regional stock exchanges, is planning to introduce the carry-forward system in order to provide greater depth and liquidity in the exchange, according to its chairman, M R Mayya. Under this system, a buyer and seller have the option to carry forward their trades to the next settlement without effecting delivery of shares sold or making payment for shares bought. Simply put, badla is the price payable by the buyer to carry over his speculative purchases to the next settlement. The system helps traders to carry-forward long positions without taking deliveries of stocks purchased. The system helps build large volumes on the exchanges and imparts liquidity to stocks.

When the seller doesn't wish to give delivery of shares sold, he pays the charges for carrying over his position into the next settlement. This is known as "undha badla" or the reverse badla. Such situations arise when there is a substantial oversold position in the market, or there are more sellers selling without having the shares in hand than buyers who do not make payments. Generally, in these cases, this occurs when the market players expect prices to fall, and sell speculatively.

As the settlement (reconciliation) is done on a weekly basis, badla is allowed for one week at a time. This is due to the fact that an individual buys or sells shares on the stock exchange within a settlement cycle, which is currently for a period of five days on the BSE. At the end of the cycle, the individual has to either deliver the shares sold, or pay money for the shares purchased. For the amount of shares bought or sold, the individual only pays a certain deposit (15-20 pc of the total value) as the margin money. The balance is arranged for him / her by the concerned broker in a badla (in lieu of) transaction.

The demand and supply of money determine badla rates in the system. This supply of money is known as "vyaj badla" (vyaj meaning interest in Gujarati), which is a financing mechanism where money is funnelled into financing carry-forward deals on BSE, as permitted by SEBI. For further information on vyaj badla, check out How to make vyaj badla work for you . The demand for money is, in turn, determined by the net outstanding position, which is the difference between the long purchases and short sales -- the former being when the buyer doesn't make payment for his buying, and the latter being when shares are sold without having physical delivery of the same. The net of these positions, at the end of the settlement, is carried forward. If this figure is large, badla rates will be higher.

As mentioned earlier, badla charges are normally levied on a weekly basis. However, when a company announces the closure of its books for determining corporate benefits like dividend, rights or bonus, the stock enters a no-delivery period for three to four weeks. Hence, in this case, a book closure badla is levied, which is for the 3-4 week period -- two weeks in case of demat stocks and four weeks in case of physical stocks. Now, ISE intends to provide badla facility on a daily and monthly basis, the former for a rolling settlement. The multiple badla system is expected to attract greater volume of trade than in BSE or NSE. According to ISE, to provide investors with greater flexibility, a monthly badla would be introduced, which would provide the required depth in the market. This could change the face of the market.

In theory, badla rates for all forms of carry-forward have to be the same. Book closure badla is easier in the case of demat shares as compared to physical shares, as in case of the latter, transfer of shares along with attendant problems of bad delivery, enhances the risk profile greatly. As a result, book closure badla rates for demat stocks are lower as compared to that of stocks in physical form. With the coming into being of compulsory demat, this problem will get sorted out soon.

While we talk of badla rates, we also have to throw light on hawala rates -- another important ingredient in the stock markets of India. The hawala rate is a making-up price at which buyers and sellers settle their speculative transactions at the end of the settlement on any stock exchange. This becomes the basis for the investor (opting to carry-forward) to buy or sell during the next settlement. This price is significant for a speculative buyer or seller for, the hawala rate is the standard rate for settling his / her trade and for carrying forward the trade to the next settlement.

The hawala rate can be better explained with a lucid example. Arjun Vyas buys the stock of Tisco at Rs 150 on Monday, the first day of the new trading cycle. By Friday (which is the settlement day on BSE and the end of that particular trading cycle), if Rs 160 were the weighted average price in the last half-an-hour, Arjun would have to carry-forward his trade at this price of Rs 160. Similarly, if the weighted average price had been Rs 140, Arjun could have managed to carry over his trade at this price. Arjun would then enter into a contract for Rs 160 or Rs 140 plus badla charges for the next settlement.

Normally, stock exchanges do not interfere with hawala rates. However, there have been instances when this has happened too. Rates have been changed to ensure safety of the markets. When the stock market witnesses a sharp fall during a settlement, the chances of broker default are extremely high. This is when the stock exchanges' administration steps in and raises the hawala rate to avert any possible default and save the system from collapsing.

As there are supporters to the badla system, there are critics galore too. NSE doesn't allow badla and is toying with the idea of introducing Options and Futures, a favourite of Western markets. The argument against badla is that it imparts artificial liquidity to the system and brokers manipulate it to benefit themselves, at the cost of the small investor. But the pro-badla chorus is of the opinion that this time-tested Indian method is best suited to our markets. Each side has a strong and weak argument for and against each other. A closing argument could be - although Options and Futures are considered excellent instruments, they can also be used to manipulate the system. For further confirmation, ask a certain gentleman called Nick Leeson or better still, the erstwhile venerable British bank of Barings!

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