The deadline of August 26 to enforce margin financing system was fixed in conformity with the reforms package

July 11 - 17, 2005

Asian Development Bank, taking note of the growing informal economy, which has matching strength to the formal one, had given a soft term loan of $400 million to Pakistan for judicial and capital market reforms with an emphasis for introducing margin financing in place of traditional badla, besides making amendments in future trade regulations.

Under that package agreed with the ADB, capital market reforms had to be achieved by the year 2005. The deadline of August 26 to enforce margin financing system was fixed in conformity with the reforms package.

Though over 60 percent of badla regime has already been phased out, reflected in the shrinking badla financing from Rs25 billion to current level of Rs12 billion, the alternative sources under margin financing i.e. banking system has not yet come up to bridge the gap creating a serious liquidity crunch in the market. Consequently, the volume of trade has gradually started declining in bourses.

Despite fast approaching date for complete phasing out of COT, it looks difficult to make the new financing system fully operational within the given time. The brokers community has attached high hopes in the on-going parleys between Karachi Stock Exchange and the SECP that badla system might be allowed to move along with margin financing. There was a loud thinking in the stock market that like India the COT and margin financing may go together in Pakistan as well.

Primarily, the objective of replacing badla or COT system with margin financing was to bring at par with international financing standards. Besides making it familiar to the foreign investors, one of the major objectives of introducing the new financing system is to put a check valve to bridle the wild rush of undocumented wealth that earlier flooded the market.

Tariq Hasan, a senior analyst associated with Atlas Securities, said that though traditional badla financing was lacking transparency and carries risks for the investors, yet it has become a habit both of the brokers and the investors due to a very long association with the old system which is in vogue for over 50 years.

The trading community at the stock market is so closely associated with badla system that even a rumor of restoration of COT gives a quantum jump to the KSE-100 index.

Tariq strongly pleaded that prior to introducing the new financing system, proper orientation of the banks, brokers and the investors with the margin financing system should have been initiated in phases to make them familiar with the new system. At present neither banks nor brokers have grasped the new system which has added to the intricacies of the delicate business of stock market. Though the Muslim Commercial Bank, PICIC and National Bank of Pakistan have announced their plans of opening margin financing counters yet they are still in the process. However, the National Bank of Pakistan has launched margin financing facility last week but that is too restricted for Karachi alone. They will be expanding their operation to Lahore and Islamabad later on.

Easy access for the investors, traders and brokers was the most appealing factor in badla financing. Contrary to badla system, the margin financing will work amongst the big investors, traders and the brokers because of documentation requirement. In fact, the new scheme will be the lending by banks and DFIs to brokers for their clients to purchase approved shares of joint stock companies listed on exchange against approved securities with the retention of at least minimum 30 percent margin prescribed by the State Bank of Pakistan.


Standard/master agreement for margin financing on mark-up basis will be signed between financier (bank) and financee (broker). For each purchase, sale margin financing transaction contract and confirmation will be exchanged. While for the purpose of maintaining adequate margins, letter of pledge and lien of securities will be signed between financier and the financee.

The small investors and the speculators of daily transactions, who constitute a major part of the total trade volume, will be out of the business due to lack of documentation. Substantiating his point of view, he cited the example of the trade volume at the Karachi Stock Exchange which faced a drastic cut from the huge volume of over one billion shares in March last to the current level of merely around 25 million shares a day. He was of the view that the ground realities should be kept in mind while making any regulatory amendment either in the capital market or any other segment of the economy.

In effect, countries like Pakistan or India where informal economy is deeply rooted for centuries mainly due to poor rate of literacy, which is the real malaise for promoting informal economy to a formidable level. India, having a much larger size of the capital market had tried to introduce the margin financing but it had to revert to the old system due to similar reasons.

The banks which had to take over the financing system were also reluctant to come into business in a big way. Actually, they are also afraid of under utilization of the funds earmarked for margin financing. That is why the banks have not yet come up to the required level of funds set at Rs20 billion by the regulators.