Liquidity concerns rise as brokers seek relief on capital market exposure rules

Liquidity concerns are mounting in the capital markets as brokerages seek relief on proposed banking exposure rules, warning that abrupt regulatory changes could strain funding, widen bid-ask spreads, and create an uneven playing field. With tighter norms already in place — including higher Securities Transaction Tax (STT) and stricter derivatives oversight — market participants say the timing of further restrictions is critical, especially when sentiment has been fragile and liquidity conditions uneven.

Speaking to ET Now, market expert Ajay Bagga said the industry’s request for relaxation is justified given the scale of the shift. “Overall, I would say it is a very fair ask… any such big change… must be grandfathered, time should be given to market participants to rejig business models,” he noted, adding that bank funding to brokerages is significant and difficult to replace quickly. He pointed out, “Overall exposure of banks… is about 1.5 lakh crores… nearly about 50%… could be at risk… who will provide that liquidity becomes a big issue.” Bagga also cautioned about structural impacts on trading conditions, saying, “Bid ask spreads will increase, the market depth will reduce… domestic brokerages come to a disadvantage.”

On the question of which aspects are most concerning, Bagga emphasised the importance of bank liquidity in supporting market functioning. “You are shutting down bank finance to a large extent… a very crucial liquidity provider… is taken off,” he said, warning that removing large funding lines quickly could hurt sentiment and trading activity. He added, “On a one-month basis to remove such a large facility… pulls out liquidity… the biggest issue is liquidity.”

Discussing possible solutions, Bagga suggested that regulators could distinguish between speculative activity and genuine market making while allowing time for adjustment. “You can ensure that you are not funding speculation… define the market maker mechanism… banks can lend for market making,” he said, stressing the need for a phased approach. “Grandfather it… give a year at least… understand the ramifications,” he added, noting the challenges firms face in raising alternative funding. He warned, “It is very difficult to raise it by 1st April… all the other brokers will get wiped out.”

The debate highlights the delicate balance policymakers must strike between safeguarding the financial system and ensuring markets remain liquid and competitive. As discussions continue, participants will be watching closely to see whether regulators provide transition measures that preserve market depth while addressing systemic risks.