By: R.M.B Senanayake
After the end of the 30 year war there was a sense of euphoria in the business sector. They would no longer have to provide for high cost insurance including terrorist cover. The market suddenly expanded to include the north and east. There was the prospect of tourism booming once again. So investors in the stock market became exuberant. As the interest rates were low and the land & property market had crashed with the shenanigans of Kotelawala and his gang, the savers were attracted to the stock market. Their Finance companies which were engaged in land sales in a big way collapsed and depositors lost faith in all Finance companies.
The Brokerage firms provided credit to investors who were short term traders. The market became the second best performer in the world according to Bloomberg. The growth was 111% and these were extra-ordinary gains indeed. But in August 2010, some stocks rose rapidly in a single trading session- way above their fundamental values on any projected future earnings. Towards September 2010 the price increases came to be dubbed an asset bubble.
The Securities Exchange Commission, the watchdog over the market introduced new rules to cool the market. They imposed a general price limit of 10% for the growth of the market on a single day. The SEC later revised it to apply the price limits to individual stocks which it considered as having gone up too high and too fast in a single trading day. On 20th September, the price band scheme was further modified and determined on a formula known only to the authorities. Buyers of the shares subject to price limits were called upon to deposit 100% of the value of such stock before purchase. This reduced the number of investors who could buy such stocks and it reduced the possibility of large price increases of such stock. Speculators who could not sell before price limit came in, suffered heavy losses. Subsequently the requirement of 10% prior deposit in cash was removed and the price limits were confined to 2 weeks.
The SEC also prohibited brokerage firms from extending credit to their clients and insisted on enforcement of the T+5 rolling settlement days. So brokers now force sell the shares of their clients if payment has not been received. The market is see sawing, going up for 2-3 days and then falling for another 2-3 days wiping out the previous gains.
Should the broker firms be debarred from extending short term credit to their clients?
The market is driven largely by short term traders rather than long term investors. The latter type of investors think the market is over-priced and waits for prices to come down.
In India there is a system call “Badla” where informal financiers extend short term credit to speculators. There are investors in the market who buy hoping to sell in a short period. Should there be no mechanism to provide them such credit. We do not have informal financiers and in the absence of such financiers the brokerage firms have provided such credit. It is suggested that the brokerage firms be allowed to provide such credit for short periods not exceeding say a month. The borrowers should be called upon to pay the interest up front on the due settlement date. If the client wants to extend the period of holding he should be called upon to pay the interest upfront for another period. The Brokerage firms should be required to see that any credit extended does not exceed 50% of the portfolio value.
The writer is an economist and is the General Manager of a stock brokering firm.
http://www.news360.lk/markets/stock-market/allow-brokers-to-extend-credit-for-short-periods