MARGIN FINANCING TO

ENTER WITH ‘ifs’ AND

‘buts’
By Dilawar Hussain
Thursday , 20th Aug 2009
www.dawn.com

MUHAMMAD USMAN ZIA

SYED ALI AHMED
SIKANDER SALEEM ALLANA
SAMEER ZAFAR
BBA V-III
 What is margin Financing?
• Margin financing is basically buying
shares on credit.
• Three parties are involved Bank, Broker
and Client.
• How is credit given?
• Ans: Situation: “Mr. Patel trades in stock
market, he has a milk shop , he is a
small investor. Mr. Patel wants to buys
some shares in stock market, but he is
out of cash to buy, Mr. Patel has some
share holdings of worth Rs 100,000”
What will Mr. Patel do now?
• Note: you need a broker to trade in
the stock market. Without broker you
cannot trade in stock market.
• Mr. Patel as he is out of cash will turn
to his broker for margin financing
(i.e. is one of the leverage products
in stock market).
• Broker will say “OK”. Broker is ready
to give margin financing, but how?
• Broker will go to the bank, he will ask the bank
to give him credit on certain interest rate.
• Broker is taking credit on behalf of Mr. Patel in
his account. The broker will pledge the shares of
Mr. Patel with the bank.
• Against the shares bank will give the credit to
the broker.
• Broker gets the credit in his name he forwards it
to Mr. Patel, he is happy he buys the shares
which he wanted to buy.
 How this will lead to
destruction of Mr. Patel
and the Broker and the
Bank? “if”
• Stock Market is going down, going
down, going down.
• Stocks are loosing prices every day.
• Mr. Patel is again out of Cash.
• Note: for the credit taken Mr. Patel is
not directly responsible to the bank,
he has to pay his liability to the
broker. Broker will payback the credit
taken back to the bank.
• Mr. Patel as he is out of cash, cannot
payback to the broker.
• For instance if there are 100 people
like Mr. Patel who have bought shares
on margin financing and are out of
cash to payback for the credit taken
• The whole burden of credit now lies on
the shoulder of broker. Broker will now
have to pay back to the bank.
• If 100s or 1000s of such people
default, broker will go bankrupt.
• Broker will not be able to payback to
the bank.
• Bank will suffer loss for the credit
provided, interest forgone, shares
pledged with the bank has already to
lost its value due to market going
down.
• Therefore everyone suffers.
 If margin financing is
introduced?
• Will banks cooperate.
• Will banks finance general investors through
the broker.
• It is a system based product, but System for
margin finance is still not working out much.
• brokers taking loans from the banks at 10/12
percent provide financing to investors at
18/20 percent.
• Will lead to no holistic solution to reduce
speculation and manipulation in the market.
• Small investors will go for margin financing
and when stock prices go down they will
again end up with nothing as in the case of
badla.
• In end of year 2008, market was ceiled with
a floor, which didn’t allowed market to go
down. This was done to stop investors and
broker from being bankrupt.
• Banks were previously financing funds worth
of Rs 100 bn but now they are providing only
Rs 35bn.
• One of the reasons for this situation was
created due to extensive badla.
 But if margin financing is not
introduced what to do?
• Reintroduction of Badla as being
demanded by people.
• WHAT IS BADLA?
• Badla Finance in simple terms means
putting money on interest.
• Situation: Mr. Patel wants to buy shares
without blocking his money. He will ask his
broker to buy shares for him from KSE 100.
• Broker buys the shares and pay to the
exchange.
• For this facility broker charges interest which is known
as “badla”.
• Note: only two parties are involved, client & the
Broker.
• E.g. Example: If "A" has purchased 1000 shares of
MCB @ Rs. 50 per share in Settlement 1, he has to
take delivery from "B" who has sold the same. "A"
would like to carry forward his position to the next
settlement by letting "C" (Badla Financier) take
delivery at the prevailing interest rate.
• In settlement 2 "A" will have to purchase the shares at
a higher badla rate as determined by the Exchange. If
the Badla was Rs. 0.20 in settlement no.1, "A" will
have to buy MCB @ Rs. 50.20 per share from "C".
• The difference in purchase price in settlement no.1,
and sale price in settlement no.2, is the earning for
the Badla Financier.
 But if Margin Financing Is not
introduced than what
• happens?
Badla will prevail.
• Speculation in market increases.
• Khali phoket investors will arrive in the
market, with no money and no willingness to
pay back the credit taken to buy shares.
• When stock market going down, going down,
going down again. People turn to distress
selling which will lead to market crashing
down and investors loosing their money.
• Which lead to people not being able to paying
of their debts.
• Badla is very high risk, you have to pay very
high interest payment.
 Badla Financing Margin Financing
•Direct Participation of Non-Brokers •Direct Participation of Non-Brokers
and Brokers and Brokers

•Maximum Financiers Participation •Depends on Banks / DFIs / Brokers

Participation as Financiers

•100% settlement obligation shifted •Minimum amount of shares pledged

to financier. 25% for ensuring Equity participation
by the financee.

•Flexible criteria for selection of •The financier to decide which

Securities . securities to finance.

•Length of contract was 22 Trading •Length of Contract to be decided by

Days. Counter Parties

•No disclosure for leverage financing •Disclosure of Entire Credit given to

the Brokerage Houses
 Badla Financing Margin Financing

•Post-trade arrangement of Financing •Pre-trade arrangement of financing

through credit lines

•Unused funding cost was not •Fix cost on credit lines continuously
involved applicable

•In case of default, forced selling
impact Equity/Futures Trading
Markets at the Exchange
•Availability of funding to all
Participants
•In case of default in MF, forced
selling will be minimum
•Availability of funding to restricted
participants