Risk to Indian equity market prospects from an alarmingly rapid increase in margin trading loans.
Business Standard, in one of its recent editions, reported that the margin trading book of Indian stockbrokers has crossed ₹1 lakh crore; five years ago, the book was valued at just ₹5,000 crores; that’s a 20-fold growth in five years; the total market capitalisation of Indian listed companies multiplied by only three times during the period. The news disturbed me, and its cause was twofold: 1) the rapid increase in margin loans and 2) the disparity between the growth rates of margin loans and total market capitalisation.
Margin loans are money lent by brokers to their clients (investors) to purchase stocks. Typically, in a margin-funded purchase, investors put in around 10 to 15% of the purchase value, while brokers loan the rest. The brokers’ benefit from this arrangement is the increased brokerage from higher transaction values and the interest they earn on the margin loans, which, under normal conditions, range from 15 to 20%.
Meanwhile, investors aspire to amplify their gains through this arrangement. A 15% margin trading facility allows an investor to buy stock worth ₹1,00,000 with a margin of ₹15,000 of their own money. If the stock gains 5% in price, it will result in an investment gain of ₹5,000 – a 33% gain on their original investment of ₹15,000. The flip side of this arrangement is that losses are also amplified if the stock’s price falls.
Investors’ success through the margin trading facility depends entirely on what happens in the short term. It is pure speculation. With a 15% margin facility, the stock should gain by at least 15% within a year for the investor to break even. Conversely, if the stock falls by more than 15%, brokers may request additional margin money or collateral from the investor. The broker will be forced to sell the stock if the investor fails to provide additional margin. In such cases, the investor loses their entire investment. The broker will also suffer losses if they have to sell the stock at a loss exceeding 15%.
The rapid growth and enormous size of the outstanding margin loan book seem distressing. However, the size appears paltry when compared to the total market capitalisation of the Indian stock market, which recently stood at ₹450 lakh crores; the outstanding margin loans account for just 0.22% of the total market capitalisation. The figure is way below global averages; in the United States, the respective ratio is 1.9%.
Interest from margin trading facilities has become a significant source of revenue for most of the leading domestic stock brokerages. In FY25, Motilal Oswal earned ₹949 crores as interest income through margin trading facilities, equivalent to 38% of the ₹2,483 crores it earned as brokerages during the year. In FY24, the ratio was 21%; five years ago, it was just 16%. For Geojit, the respective ratio – interest income from margin loans as a percentage of brokerage income – has increased from 11% to 31% over the last five years. The ratio increased from 23% to 40% for Angel Broking over the same five-year period. Moreover, as of 31 March 2025, outstanding margin loans equalled 132%, 131%, and 45% of net worth, respectively, for Motilal Oswal, Angel Broking, and Geojit.
The last five years witnessed a boom in the Indian stock market, corroborated by the annual growth rate of 23% in total Indian stock market capitalisation during the period. However, the boom seems to have stalled over the past year. Many consider the past year a period of consolidation for Indian stocks and expect the uptrend to resume soon. It may or may not. Only time could tell. However, it is unambiguous that the rapid growth in margin loans during the past five years has played a significant role in fuelling the Indian stock market boom since 2020.
Favourable global economic conditions and the ‘India growth story’ narrative had fuelled the boom. But things are different today. Global conditions are currently more hostile than favourable: higher interest rates, a persistent threat of high inflation, and hostile trade policies are a few reasons. The ‘India growth story’ narrative may also be faltering, as suggested by the six consecutive quarters of poor earnings growth by Indian companies. However, the resilience of Indian stocks, despite poor earnings, is quite confounding.
People always overdo things; it doesn’t matter whether they are optimistic or pessimistic. It is a human inclination. We are emotional beings. Our prevailing mood heavily influences the kind of thoughts we have at any moment. And we have no idea how our moods can swing in response to various external stimuli.
The overdoing of optimism creates excesses in the system. When the market or economic cycle turns, it triggers the unwinding of the excesses. Worryingly, such unwinding has serious adverse ramifications for stock prices. Investigate any of the significant excesses in market history. You will find that all had an important common denominator: rapid growth in the supply of credit to a particular group of people. In the case of margin loans, which have seen rapid growth in recent years, that group of people are the speculators. Credit inflames speculation. Credit is the enabler of excesses, manias, and bubbles.
The rapid growth in margin loans happened because it was beneficial for both brokers and speculators. Two conditions are essential for margin loan arrangements to remain helpful for both parties: 1) interest rates must remain low, and 2) stock prices must keep delivering above-average returns. Interest rates aren’t as low as they were three years ago. RBI had raised policy interest rates from 4.00% in 2022 to 6.50% in 2023 and has then reduced them to 5.50% this year. After delivering above-average returns since 2020, Indian stocks reached a peak in September 2024. Since then, they have stagnated.
The higher interest rates and stagnating stock prices indicate that conditions for margin loans aren’t as favourable anymore, particularly for speculators, for whom it has become a costly affair. They must pay interest on margin loans, but there are no stock gains to offset the cost, which means they must either pay it from their own funds or pare their positions.
What would speculators choose: pare down their positions or pay it from hand? If they choose the former, then a 30% unwinding of the total outstanding margin loans would bring ₹30,000 crores worth of stocks to the market. Domestic institutions invest an average of ₹40,000 to ₹50,000 crores every month in the market. This could easily absorb the margin loan unwinding. Domestic institutional fund flows have already buffeted markets against foreign institutional outflow this year.
However, continued strong domestic institutional fund flows are not a given. Changes in the external economic environment can cause wild mood swings that could trigger highly unpredictable market behaviours. Major Indian stock market indices fell 50% to 70% in 2008. What caused it? A global financial crisis, whose origin lies in the US subprime mortgage market, the risk from which was spread among major advanced economies through complex financial instruments such as CDOs and CDSs. The Indian economy and financial system had negligible to nil exposure to any of these risks. Despite that, our stock market fell more than 50%. Mood swings and their impact on risk perception are rapid and unpredictable.
The US economy and financial markets have been in a precarious position since the interest rate hikes of 2022 and 2023. High valuation, excessive market concentration in technology stocks, ballooning federal debt and deficits, and constant threat of inflation are a few reasons. However, despite the precariousness, US stocks have continued to rise and are at record highs today, primarily driven by the excitement surrounding artificial intelligence.
The financial historian, Niall Ferguson, in his book ‘The Ascent of Money’, parses a bubble into four stages. In the first stage, known as ‘displacement’, certain changes in the economic environment open up new and profitable opportunities for a few companies. In the second stage, ‘euphoria’, the expectation of rising profits triggers a fast rise in stock prices. In the third stage, ‘mania’, the rapid rise in stock prices seduces people to engage in widespread speculation for easy and quick profits. In the penultimate stage, ‘distress’, insiders begin to have doubts about whether these companies can meet the extremely high profit expectations incorporated into their exorbitant stock prices. They start to sell. The selling causes stock prices to lose their momentum. In the final stage, ‘panic’, as scepticism from insiders spreads to the public, several investors start rushing simultaneously towards the exit to protect themselves from falling stock prices. The rush, however, exacerbates the fall.
Indeed, a bubble is forming in US artificial intelligence-related stocks, whose deflation will have global consequences. But it seems to be in a very early stage. Presumably, in the euphoria stage. Moreover, the bubble doesn’t have to transition to a mania stage, meaning it could deflate without developing into a full-blown mania. The adverse consequences of deflation would then be limited.
Even if the AI bubble deflates, its consequences on Indian stocks are indeterminate. As the bubble has burst, money will search for opportunities elsewhere, and foreign investors may find Indian stocks attractive again. Alternatively, the burst of the bubble might dampen investor sentiments, making them risk-averse. Investors would then view the elevated valuation of Indian stocks as too risky, possibly triggering a decline in the valuation and prices of Indian stocks.
My analysis task at any time has either of these two purposes: 1) evaluating Indian stock prospects to find profitable investment opportunities, or 2) assessing the investment environment for signs of distress or displacement. The intention of this content is the second one. Among the four stages of a bubble that we saw earlier, the ‘distress’ and ‘displacement’ stages are the most consequential for an equity investor. Most profitable investment decisions can be made during these stages. These two stages are points of reversal: displacement suggests a reversal for the better, and distress suggests a reversal for the worse. Every equity investor aspires to buy at the first sign of displacement and sell at the first sign of distress. However, in reality, most buy during euphoria or mania and sell during panic.
What should Indian equity investors be looking for now: signs of displacement or signs of distress? Even that is uncertain now (I am inclined towards the latter). The uncertainty arises because, if we consider that Indian stocks have been consolidating for the past year, we should be looking for signs of displacement that could indicate the end of consolidation and the resumption of the uptrend. However, since we had four years of stock market boom and current stock valuations remain elevated, shouldn’t we be looking for signs of distress?
What do you believe in? Do you think Indian stocks are consolidating and will soon resume their uptrend, or do you believe they have peaked, with current price levels being unsustainable and will quickly moderate towards their equilibrium levels? I wish to choose neither side. I want to keep my options open. I have spent enough time in markets to form this opinion. But this content and its exploration are a search for signs of distress in the rapid expansion and the humongous size of the margin trading books of Indian stockbrokers.
Presently, in the Indian stock market, the margin trading loans arrangement has become unfavourable for the speculator. The speculator had intended to service the loans (pay interest) from his stock gains. But stocks have stagnated for the past year, which means the margin loans are serviced using money from elsewhere. Why would he hold onto such a costly arrangement? Why doesn’t he sell the stocks and close the margin loans? Because he hopes stocks will rise, sooner or later. However, there is a limit to how long he can remain sanguine in a costly arrangement. Once those limits are breached, hope turns to despair, which undoubtedly will hurt stock prices.
Stockbrokers won’t call off their margin loans so long as speculators service them regularly. Margin loans are highly risky, yet also very lucrative. But the situation can become complicated in two ways. It could happen if speculators voluntarily close their margin positions, losing hope after prolonged periods of stagnant stock prices. It could also occur if speculators fail to meet the increased margin requirements set by stockbrokers due to a sudden and sharp drop in stock prices. The former scenario happens gradually, and hence, its adverse impact on stock prices will also be gradual and limited.
However, the latter scenario is more serious. They usually happen due to an unexpected and significant exogenous shock to the financial system. Tightening of regulatory conditions is one standard exogenous shock. However, regardless of the source and nature of the shock, exogenous shocks significantly alter the risk perception of market participants—the collective mood shifts to extreme pessimism. Every action will have a cascading effect, worsening the already complicated situation.
There were several minor and major exogenous shocks over the past year. Trump’s April 2 liberation day tariff shock was a major one. Stocks fell sharply then, but the recovery was much faster. Trump’s decision to escalate tariffs on Indian imports to 50% on August 6 was another exogenous shock. However, it received a lukewarm response from the market. The exogenous shock that can shatter investors’ trust and confidence in the system, and whose impact could last for a long time, can only be known in hindsight. We can’t foresee them, but we could prepare ourselves for them.
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