What do RBI’s new rules mean for investors in exchange and brokerage stocks?

Mumbai: The Reserve Bank of India (RBI) has updated the norms for banks’ loans to brokers and capital market intermediaries (CMIs) in an attempt to bring in more transparency to such lending activities. Shares of BSE fell 7.5% on Monday, while brokerages Angel One and Groww declined 5% and 1.7%, respectively, after the new rules are set to take effect on April 1. A look at the details of the new rules and their impact.

What are RBI’s new rules for banks’ loans to brokers?

The RBI circular reshapes the lending relationship between banks and brokers by tightening collateral norms and standardising loan-to-value (LTV) ratios – the proportion of a loan relative to the value of pledged securities.

The central bank said all credit facilities to brokers and related intermediaries shall be provided on a fully-secured basis or backed by 100% collateral. Banks may also lend to individuals against eligible securities, with an LTV of 60% against listed shares and listed convertible debt securities, and 75% for mutual funds (excluding debt MFs), units of ETFs, and units of REITs and InvITs. Earlier, LTV norms were not standardised, typically ranging between 50% and 70% for mutual funds and between 80% and 90% for debt mutual funds.

Banks will also be permitted to lend to brokers for the MTF book against 100% collateral. Currently, brokers largely fund their MTF books through commercial paper borrowings.

What will be the impact of these changes?
Proprietary trading desks are expected to take the biggest hit as these firms relied heavily on bank-backed funding and guarantees to take higher trading exposures.

“Margin requirements for brokers for making a bank guarantee (BG) could rise from 50% to 100%, reducing leverage and consequently proprietary trading activity in the market,” said Ashish Nanda, Digital Business Head, Kotak Securities. Currently, brokers can keep 50% funds with banks and receive up to twice the amount as bank guarantees (BGs), which were submitted to clearing corporations to double the trading capacity.

“The largest impact is expected on proprietary trading, which accounts for nearly 50% of options volumes and around 30% of cash market and futures volumes,” Nanda added.

Banks’ lending to brokers will also face greater scrutiny in terms of collateral requirements, as well as the purpose of the loan.

“Collateral requirements for intra-day working capital or margin borrowings, which brokers can access only through banks, will also rise from 50% to 100%, increasing borrowing costs and potentially leading to a higher cost of capital for brokers,” said Ashish Rathi, chief operating officer at HDFC Securities.

OTHER THAN PROPRIETARY TRADERS, WHO ELSE WILL BE IMPACTED?
Brokers said the new rules will likely impact intra-day trading. Since the new rules require brokers to put up 100% collateral for intraday borrowing — and 50% of that must be cash — their cost of funding is set to go up. “Regular retail brokers who give their clients intraday leverage are caught in this too,” said Zerodha in its blog. “Either they cut client limits, or they lock up way more capital.”

WHAT ABOUT MARGIN TRADING FACILITY (MTF)?
Zerodha said the impact of the RBI rules on Margin Trading Facility (MTF) — where brokers lend money to clients to buy shares — could be limited for bank-owned brokers but will be felt by independent firms. Bank funding accounts for only about 20% of the overall MTF book, and nearly 90% of that is with bank-owned brokerages, the blog said. For these firms, the parent bank can provide capital, which is then pledged back as collateral, it said. For independent brokers, profitability could be squeezed if the cost of funding rises because of tighter collateral norms. “We believe credit facilities with 100% (or higher) collateral will make the bank channel unsuitable for brokers, and they will only use it for short-term mismatches,” said analysts at JM Financial, in a note to clients.

HOW WILL THE RULES IMPACT TRADING VOLUMES?
Rathi said the maximum impact of these norms would be on the earnings for brokers and exchanges, as derivatives volumes may further take a hit. “While we do not expect any meaningful impact on clients or cash market volumes, the impact of the RBI circular, along with an increase in STT for options and futures, may reduce volumes in options by 15 -20%,” he said.