Published On: Sat, Dec 24th, 2011

Curb Rise in Proprietary Trading and Derivatives: Reserve Bank Of India

The rising share of derivatives and higher proportion of proprietary trading need to be monitored, the Reserve Bank of India (RBI) said on Thursday. In its fourth Financial Stability Report, the central bank underlined structural changes that the equity market has undergone in terms of the extreme contrast of the volume activity in the cash and derivatives market as well as the composition of trading activity between institutional and non-institutional investors. “In the interest of financial stability, these micro-level developments need to be monitored as potential sources of systemic risk,” cautions the report.

The report notes that the average daily cash market turnover and delivery on stock exchanges during the last two years have been declining. “This is in contrast to a rapid growth in value of traded contracts in equity derivatives, where index options have replaced index futures as the most traded contracts. The ratio of cash market turnover to derivatives market turnover has dipped in recent months,” the central bank noted.

According to the latest data, the average daily turnover of the cash market for December dropped to R9,918 crore, its lowest levels since February 2009.

Further, the central bank noted changes in the composition of trading activity. While the share of institutions has remained stable, that of non-institutional clients including retail clients has fallen sharply in the cash segment. The share of proprietary trading in derivatives segment has gone up considerably from 35% in 2008-09 to 48% in 2010-11 whereas the share of non-institutional clients has declined from 59% to 42% during the same period.

According to the report, a preliminary study of impact of trading by FIIs (foreign institutional investors) and MFs (Mutual Funds) revealed that equity markets are likely to be more vulnerable to FII flows. On role of MFs during heightened market activity by FIIs, the report said the ratio of net MF investments to net FII investments is only 0.22.

The report also highlights the correlation between the exchange rate fluctuations and equity market. “During times of risk aversion, coupling between the rupee and domestic equity market is much higher. FIIs’ selling in equities is matched by their demand for US dollars to repatriate capital to their own jurisdictions. This externality that the equity market gyrations pose on a macroeconomic variable like the exchange rate is not conducive to financial or macroeconomic stability,” it says.

While it highlights the impact of the global sovereign debt crisis on Indian Financial markets through increase in market volatility and risk aversion, the report stresses on some domestic factors which could intensify the negative impact. “Depreciation of the rupee, widening current account deficit and rising net international liability position, though not a cause for undue immediate concern, have enhanced the vulnerabilities of the external sector,” the reports says.

Source: The Financial Express

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