India’s central bank is moving to restrict how banks fund proprietary trading activity, a step that trading firms say could hit margins, reduce derivatives volumes, and push some business offshore. The Reserve Bank of India’s proposed changes would prohibit banks from lending for proprietary trading and require 100% collateral for other funding extended to brokers.
The rules are due to take effect on April 1. Executives and analysts told Reuters that the tighter funding framework could cut profit margins by as much as half and reduce derivatives trading volumes by up to 20%. Reuters spoke to executives at six domestic and foreign trading firms; all declined to be named because they were not authorised to speak publicly.
The RBI’s move follows earlier steps by policymakers to cool India’s fast-growing equity derivatives market, which has drawn large numbers of retail investors. An official study found that nearly 90% of small investors in derivatives suffered losses, adding to concerns about household financial risk.
Under current rules, proprietary trading firms rely on bank financing to boost leverage. That leverage allows them to deploy larger positions and generate outsized returns, often competing with retail investors who lack similar access to capital and technology.
If bank funding is curtailed, firms would need to tap alternative sources of capital, which executives say are more expensive. That would erode margins and limit the scale of trading strategies.
“Domestic proprietary trading firms fear that their business model has been rendered obsolete,” an executive at a mid-sized domestic firm said.
“Large firms may still have some of their own capital to deploy but this will impact their growth prospects,” said the head of a large domestic high frequency trading firm.
The National Stock Exchange of India is the world’s largest venue for equity derivatives, accounting for around 70% of global index options trades, according to the World Federation of Exchanges. Proprietary trading represents nearly half of overall derivatives trading on the NSE by value, and high-frequency trading firms account for roughly half of that segment, according to Jefferies.
Analysts say smaller proprietary trading firms are the most exposed. Mumbai-based brokerage IIFL said in a note that “smaller proprietary firms that historically leveraged broker funding will be squeezed hardest because they lack large balance sheets or alternate credit access.”
Without cheap bank funding, these firms may struggle to compete with larger players that can deploy internal capital or access international financing. Some executives warned that this could lead to consolidation or even closures among smaller domestic operators.
The reaction from trading firms mirrors pushback from the brokers’ lobby, which has urged a six-month suspension of the proposed changes to allow time for feedback and impact assessment.
Executives said foreign trading firms may reconsider plans to expand in India and instead route activity through offshore centres where financing costs are lower. Three executives told Reuters that existing operations could also be shifted abroad, potentially giving foreign firms a competitive edge over domestic players constrained by local rules.
Policymakers have grown uneasy as India’s derivatives market expanded to more than double the size of the underlying cash market, far above the 2-3% ratio seen in major global markets. Previous measures have included raising fees on derivatives trades, cutting the number of contracts offered, and increasing taxes on trading profits.
While those steps reduced the number of contracts traded, the total value of derivatives activity has remained elevated, suggesting that large pools of capital are still active. The RBI’s funding curbs represent the most direct attempt yet to limit leverage in the system.
The Reserve Bank of India and the Securities and Exchange Board of India did not respond to requests for comment.
If implemented as planned, the rules would alter the economics of proprietary trading in one of the world’s busiest derivatives markets, testing whether tighter funding conditions can temper volumes without driving activity beyond India’s borders.
