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By: R.M.B. Senanayake
The stock market continues to decline and we may be heading for a long bear market if the rule which prohibits all credit extension by the Broker firms is not revised. The market has been dominated by speculative investment rather than long term investment. But speculators need to borrow to leverage their positions. The SEC converted the market overnight into a cash market and insisted that trades must be settled on t+5 with no credit being permitted by the broker firms to clients. But there should be no objection to broker firms extending credit provided there are limits which the brokers must conform to. The rule of extending credit on the collateral of the client’s portfolio was limited to 50%. This is a safe margin since the market will not decline by 50% overnight. If the 50% portfolio value falls due to market movements and credit has been extended up to that limit then a margin call must be made by the broker firm and the client must cough up cash to meet the margin call and this must be met within 24 hours. But the rule was not enforced. Rules which are not enforced by the authorities are useless. Had the Rule been enforced then the market would not have gone to such giddy heights which could not be sustained.
It is necessary to impose a limit also on the aggregate credit to be extended by the broker firms. This has to be based on the net capital. Presently the SEC has imposed a limit based on the liquid assets of the broker firm. But the liquidity requirements are already in place and these liquid assets are to be in cash deposited with the Stock Exchange. There seems to be no need to base the aggregate credit limit on the liquid assets. The brokers association wants leverage of 4 times while presently the SEC does not permit any leverage. The banks are permitted to lend up to 10 times their deposits although many of our banks do not do so. Perhaps the SEC should allow some leverage and review it from time to time to determine what is suitable for our market. Stockbroker firms are classified as shadow banks since they can create new money like the banks. But unlike the banks the risk of default is much less and more controlled since the credit extended is backed by portfolios of shares. What is required is to enforce the regulations regarding the credit limits and ensure that the brokers raise margin calls when necessary and then force- sell only where the margin calls are not honored by the client.
The writer is an economist and is the General Manager of a Colombo based stock brokering firm. You can reach him via raja.senanayake712@gmail.com
http://www.news360.lk/markets/stock-market/longer-bear-market-if-the-credit-rule-is-not-revised
The stock market continues to decline and we may be heading for a long bear market if the rule which prohibits all credit extension by the Broker firms is not revised. The market has been dominated by speculative investment rather than long term investment. But speculators need to borrow to leverage their positions. The SEC converted the market overnight into a cash market and insisted that trades must be settled on t+5 with no credit being permitted by the broker firms to clients. But there should be no objection to broker firms extending credit provided there are limits which the brokers must conform to. The rule of extending credit on the collateral of the client’s portfolio was limited to 50%. This is a safe margin since the market will not decline by 50% overnight. If the 50% portfolio value falls due to market movements and credit has been extended up to that limit then a margin call must be made by the broker firm and the client must cough up cash to meet the margin call and this must be met within 24 hours. But the rule was not enforced. Rules which are not enforced by the authorities are useless. Had the Rule been enforced then the market would not have gone to such giddy heights which could not be sustained.
It is necessary to impose a limit also on the aggregate credit to be extended by the broker firms. This has to be based on the net capital. Presently the SEC has imposed a limit based on the liquid assets of the broker firm. But the liquidity requirements are already in place and these liquid assets are to be in cash deposited with the Stock Exchange. There seems to be no need to base the aggregate credit limit on the liquid assets. The brokers association wants leverage of 4 times while presently the SEC does not permit any leverage. The banks are permitted to lend up to 10 times their deposits although many of our banks do not do so. Perhaps the SEC should allow some leverage and review it from time to time to determine what is suitable for our market. Stockbroker firms are classified as shadow banks since they can create new money like the banks. But unlike the banks the risk of default is much less and more controlled since the credit extended is backed by portfolios of shares. What is required is to enforce the regulations regarding the credit limits and ensure that the brokers raise margin calls when necessary and then force- sell only where the margin calls are not honored by the client.
The writer is an economist and is the General Manager of a Colombo based stock brokering firm. You can reach him via raja.senanayake712@gmail.com
http://www.news360.lk/markets/stock-market/longer-bear-market-if-the-credit-rule-is-not-revised
