Zerodha founder and CEO Nithin Kamath has cautioned that the sharp rise in margin trading facility (MTF) exposure across brokerages could pose a significant risk to India’s stock market ecosystem in the event of a market correction. In a post on X, the Zerodha co-founder noted that MTF books are expanding rapidly despite Indian equities moving largely sideways in recent months.
MTF enables investors to purchase stocks by borrowing money from brokers, using pledged shares or margin as collateral. The product has expanded rapidly over the past two years amid rising retail participation in equities, with investors increasingly leveraging it to boost returns, particularly in mid-cap and small-cap stocks.
Key risks during sharp market declines
Kamath said one of the key risks arises during sharp market declines, when brokers may find it difficult to liquidate pledged stocks quickly enough to recover borrowed funds. “The big risk with MTF is the risk of the stock becoming illiquid in case there’s a sharp market fall,” he said. He further explained that if stock prices fall beyond the margin provided by customers, brokers are left exposed to losses. “If a stock moves more than the margin provided, say 20 per cent, the bad debit is on the broker,” Kamath said, adding that recovering money from customers in such cases is often challenging.
According to him, the risk increases significantly when investors use pledged shares as collateral to take even larger leveraged positions in the same stock. “A customer pledges Stock A, gets 80 per cent margin on it, and uses that to take further positions worth 400 per cent in the same stock,” he said.
What else?
Kamath warned that such structures can become particularly risky in mid-cap and small-cap stocks, where lower liquidity and circuit limits can prevent brokers from exiting positions during market stress. “If that stock is a mid or small-cap stock, circuits kick in, and there’s simply no exit if markets turn around,” he said.
He also said that nearly 50 per cent of the industry’s MTF exposure is currently concentrated in non-futures-and-options stocks, a segment typically seen as less liquid compared to large-cap F&O counters. The Zerodha founder added that his brokerage still does not permit customers to use collateral margin for MTF purchases, although competitive pressure in the industry may eventually force a change. “While we still don’t allow collateral margin for buying MTF, competitive pressure would mean we will have to,” he said.
Kamath added that Zerodha’s own MTF book has grown significantly over the past 16 months but still stands at about 25 per cent of the company’s net worth. However, he noted that for some brokers, MTF exposure could be as high as 500 per cent of net worth, which is the maximum limit permitted under current regulatory norms.
