Nithin Kamath, the CEO and co-founder of Zerodha, has pointed out that brokers are facing increasing risks due to the quick growth of margin trading facilities (MTFs), which could increase losses in the event of a severe market drop.
MTF Expansion Raises Broker Risk Concerns
According to Kamath’s post on Social Media platform X, the industry’s exposure to MTFs has increased by about five times over the last four years to over Rs 110 lakh crore, partly due to greater margins and securities transaction tax (STT) in the futures and options (F&O) sector. He did, however, issue a warning, pointing out that although leverage has significantly grown, brokers are not using a true risk model.
According to existing legislation, brokers can offer up to five times leverage on a variety of stocks with a mere 20% margin from customers. The fierce competition among brokers, according to Kamath, has caused most firms to provide the highest amount of allowable leverage. “You lose business if you don’t. “It is a traditional race to the bottom,” he remarked.
📊 India’s MTF Exposure Surge
- Growth: Nearly five-fold rise in four years
- Total Exposure: Over Rs 110 lakh crore
- Driver: Higher margins and STT in F&O segment
- Leverage: Up to 5x permitted under regulations
- Risk: No robust risk model for brokers
Why MTF Risks Are Higher Than F&O
Additionally, Kamath contended that compared to F&O trading, MTF has greater and more complicated risks. MTF positions can stay open for months, in contrast to derivatives positions, which are usually kept for days. Furthermore, compared to about 200 extremely liquid equities in the F&O world, MTF is allowed in about 1,300 stocks, including many illiquid names. Because MTFs primarily include long-only positions, they restrict natural two-way market flows that aid in price stabilization, which increases the risk.
Additionally, he emphasized how accepting equities as collateral results in an increase in debt. For instance, after a haircut, a client with shares valued at Rs 1 lakh may receive collateral of Rs 80,000, which they could use to open MTF positions up to Rs 5 lakh. Kamath said, “This is when leverage goes nuts.”
⚠️ Market Crash & Forced Liquidation Risk
- Liquidity: Dries up quickly during downturns
- Support: Limited short-selling via SLB mechanism
- Impact: Forced selling becomes self-reinforcing
- Risk Zone: Non-F&O and mid/small-cap stocks
- Outcome: Cascading price declines
Liquidity Concerns During Market Downturns
Kamath cautioned that during market downturns, India’s equities markets frequently lose liquidity quickly, particularly outside of large-cap stocks. When prices decline, there is frequently little natural buying support since there is little short-selling activity through the securities lending and borrowing (SLB) mechanism. Under these circumstances, especially in non-F&O equities, forced liquidations brought on by margin calls may become self-reinforcing.
In order to prevent broker defaults, the Securities and Exchange Board of India (SEBI) has capped MTF exposure at 50% of a broker’s net worth plus borrowings or up to five times net worth. However, according to Kamath, these measures mostly protect the system from broker failures rather than from widespread client defaults.
Why the Next Market Crash Could Be Worse
Since MTF scaled up, there has not been an event like the ones that occurred in 2008, 2015, or COVID. When we do, it will lead to chaos because forced selling into illiquid markets will cascade, not because any broker fails,” he stated.
Beyond the top 200–300 stocks, where liquidity is lower, Kamath continued, the effects of such a drop would be much severe. In response to inquiries concerning risk management frameworks, he stated that there is not really a solid model in existence. “Yes, there is a model if ‘praying’ that equities do not decline counts,” he stated.
He went on to say that a sharp decline in the market might wipe out a significant amount of the interest income and possibly even capital that brokers made during the MTF boom.
Frequently asked questions
1. Margin Trading Facility (MTF): What is it?
With MTF, investors can purchase stocks with only a portion of the whole value (often 20%), with brokers providing up to five times the leverage.
2. Why do brokers worry about the rapid growth of MTFs?
Because, particularly in illiquid stocks, high leverage can increase losses during market crashes, resulting in forced selling, customer defaults, and liquidity stress.
3. In what ways is MTF trading riskier than F&O trading?
In contrast to F&O, which has shorter holding periods and two-way trading, MTF positions can remain open for months, involve over 1,300 equities (many of which are illiquid), and are primarily long-only.
4. Are MTF risks completely protected by SEBI regulations?
Although SEBI limits MTF exposure in order to minimize broker defaults, these precautions do not completely defend against cascade forced liquidations or large customer losses.
5. What occurs when the market declines sharply?
A self-reinforcing cycle is created when liquidity rapidly dries up, forced selling is triggered by margin calls, and prices may decline further, particularly outside of the top large-cap stocks.
Conclusion
The warning from Nithin Kamath reveals a systemic risk that is developing beneath India’s stock markets. Although SEBI’s MTF protections lessen the likelihood of broker failure, they do not do much to stop systemic stress brought on by excessive leverage, illiquidity, and forced selling during severe corrections.
The next significant market collapse, when broker profitability, investor cash, and market stability could all be at jeopardy, will be the true test as MTF exposure keeps rising.
Disclaimer:
This content is for informational purposes only and should not be considered financial or investment advice. Market investments involve risk. Readers are advised to consult a qualified financial advisor before making any investment decisions.
