New regulations from India’s central bank, the Reserve Bank of India (RBI), restricting bank funding for proprietary trading could drive trading firms offshore and potentially force smaller entities to close. The proposed changes, effective from April 1, prohibit banks from lending for proprietary trading and mandate 100% collateral for other funding to brokers. Executives at six trading firms, speaking anonymously to Reuters, anticipate profit margin cuts of up to 50% and a potential 20% drop in derivative trading volumes. Policymakers are concerned about spillover risks to household finances and the wider economy as the derivatives market has grown to be more than double the size of the underlying cash market.
Currently, trading firms leverage bank financing to amplify profits. The new rules will force them to tap pricier capital sources, significantly eroding margins. One executive from a mid-sized proprietary trading firm stated their business model may become obsolete. A head of a large domestic high-frequency trading (HFT) firm noted that while larger firms may have capital reserves, their growth prospects will be impacted. IIFL, a Mumbai-based brokerage firm, highlighted that smaller proprietary firms lacking large balance sheets or alternative credit access will face the most significant challenges. The National Stock Exchange of India (NSE) is the world’s largest venue for equity derivatives. Proprietary trading accounts for nearly half of overall derivative trading on NSE by value.
The pushback from trading firms mirrors concerns from brokers, who have requested a six-month suspension of the rule changes to assess their impact. Executives fear that foreign trading firms may halt expansion plans in India or relocate operations to offshore centres with cheaper financing, gaining a competitive advantage. Previous measures to cool the derivatives market, such as increased trading fees and taxes on profits, have only partially succeeded in reducing trade volumes.
