In the past few months, the RBI governor has repeatedly spoken about “diversion” of household money from the bank deposits to stock markets. He has in particular mentioned rising household (retail) participation in the derivative trading, as a cause of concern for the financial stability. The securities market regulator (SEBI) has also cited high retail participation in the derivative segment as a systemic risk to the financial markets.
For a common man like me, it is difficult to understand how option buying by retail investors possess any challenge or risk to the financial system and markets.
My understanding of the securities markets is very elementary. Whatever little I understand, it works like this.
Registered and/or authorized market intermediaries are not allowed to receive from or give cash to their respective clients. This implies that all legal transactions in the stock markets are settled through the banking system.
When someone buys a security, there is necessarily a counterpart seller. The seller could be an existing owner of thy security or the company that is issuing new shares. The transaction is mandatorily settled through the banking system. Which means, the money used for transacting in the securities market never leaves the banking system. It is reasonable to say that the stock market transactions do not adversely affect the banking system liquidity.
Moreover, the money used for the securities market transactions is mostly held in low-cost savings or current accounts, enabling banks to earn higher margins. In case of derivative trades most of the money involved is held in the current accounts, as margin money or otherwise, helping the banking system most.
The problem is that the money in savings and current accounts (demand deposits) can be withdrawn anytime. Therefore, the banks cannot use all of this to give longer duration loans, lest it will cause an asset liability mismatch (ALM) in their books. This is what the governor Das hinted in his statement on monetary policy last week.
The solution to this problem may not lie in discouraging households to invest/trade in securities. The solution should be found in reviewing the banking regulations and practices to factor in the structural shift in household finances. For example, (i) banks may be told to offer competitive rates on deposits; (ii) saving deposit rates may be linked to weighted average call market rates and revised quarterly; (iii) rules for maintaining reserves by banks may be reformed. E.g., the RBI may consider prescribing lower reserve ratios for the current account balances of market intermediaries like stocks exchanges, clearing corporations, stock brokers, mutual funds, PMS, AIF, etc.; (iv) create specialized development institutions for project lending, which can raise money at competitive rates from local and overseas markets; and (v) develop a vibrant retail debt market to enable companies to raise money at market driven rates for projects.
Insofar as derivative trading by retail traders is concerned, the regulators should be more concerned about systemic risk management and not get into the morality of the practice. Hike margins and prevent market manipulation. Creating additional entry barriers (higher contract size etc.) will only push the traders towards unauthorized/illegal markets, that will not only cause them bigger losses but also take the cash out of the banking system.
