Sucheta Dalal :Manic Monday: The good the bad the ugly
Sucheta Dalal

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Manic Monday: The good, the bad, the ugly  

May 24, 2004

"After this nobody can ever question whether the Indian market is safe or not" --Ravi Narain, Managing Director, National Stock Exchange


No global capital market has witnessed a 25 per cent collapse in stock prices in just two trading days (May 14 and May 17) in decades. On Manic Monday, the 15 per cent drop happened in a total trading time of around 15 minutes with one circuit break. The reasons for this blind panic will have to be investigated and explored, in order to prevent a recurrence. But before that happens, here are some initial facts.

The biggest takeaway from the crash is that the Indian capital market system emerged unscathed from a catastrophic fall in prices that tested almost every prescribed parameter for risk protection. Sanity was restored within the trading day, leading indices retraced some of the fall and most importantly, the two national exchanges did not report a single broker default. ‘‘After this, nobody can ever question whether the Indian market is safe or not,’’ says a relieved Ravi Narain, Managing Director of the National Stock Exchange (NSE). And it was indeed an achievement that was even recognised by world regulators who had gathered at Jordan for a meeting of the International Organisation of Securities Commissions. While ignorant politicians continue to rant about mythical bear cartels, lets take a look at the things that worked on Monday and those that didn’t. What certainly worked excellently was the co-ordination between the two national stock exchanges. Their traditional rivalry was buried as executives at all levels worked around the clock to avoid defaults. In fact, officials in the risk group of the National Stock Exchange (NSE) didn’t go home from Friday, when the Sensex fell 330 points until after the horror of Monday had been tackled. And they persuaded brokers to bring in a hefty Rs 370 crore in additional margins on Monday alone.

Coordination between the bourses, regulators and the government also worked positively that day with everybody using their core strengths to avoid defaults. Purchases by financial institutions did indeed prop up market sentiment after the second circuit break; normally one would argue against such intervention, but Monday was extraordinary and needed drastic action. Hopefully, such institutional intervention will not be warranted again for a few decades. The drop in stock prices was so fast and terrifying that a broker said, ‘‘It was as though stocks were hastily jumping off the 27th floor of Jeejeebhoy Towers’’. A ten per cent breakdown in prices in ten minutes flat, with low trading volumes was bound to cause stunning losses, panic, anger, frustration, frayed tempers and hysteria. The rolling settlement system dynamically computes value at risk margins on a continuous basis during trading. When prices rise or fall, the trading limits are adjusted accordingly. And if the margin falls below the mandated level, broker terminals are automatically disabled from the system and reconnected as soon as additional funds are brought in to top the margin.

Often, this forces brokers to force investors to square off their positions and probably exacerbates the panic a little, but it is a part of the automated trading system that investors have to live with. Contrary to smart alec suggestions that margin rules should have been relaxed in the middle of the meltdown, such a move would have only weakened the system. Margins are sacrosanct and their ruthless collection protects the integrity of the trading systems in the toughest possible situations. Brokers cribbing about the present system would do well to remember April, 1992. After the big crash in prices after the Harshad Mehta scam, the market remained closed for over a week as the Bombay Stock Exchange (BSE) struggled to cope with the aftermath and the defaults.

One big weakness that has emerged from May 17 is the response of the banking system to crisis. Most clearing banks, barring HDFC Bank, acted unconcerned and unconnected to the market panic. When brokers brought in additional money to have their terminals reconnected, they were callous enough not to credit the funds instantly or report it to the bourses. Often, they confirmed payments only when exchange officials called them for information. Canara Bank was allegedly the most insensitive, and at one stage even tried to limit cheques deposited by each broker

For several years now, banks have lagged behind the capital market in terms of automation and modernisation. But their poor response to a crisis is an issue that SEBI will have to take up with the Reserve Bank of India. Ironically, the RBI itself was extremely responsive that day. It not only offered liquidity to banks on the day of the crash, but eased the panic further by lowering margin for lending against shares.

Another problem area was with large brokering firms that act as clearing members for smaller brokerages. For instance, IL&FS Investmart, a broker which is a NSE clearing member for several smaller outfits had its terminals disabled after someone needed additional margins. Consequently, all brokers who cleared their trades through IL&FS Investmart were forced on to the verge of a default. After a long period of suspense Investmart was re-connected and the constituent brokers scraped through without a problem. Stock Exchange sources agree that this problem needs fixing. Clearing brokers may be asked to organise a bigger line of credit or find other ways to protect brokers who clear trades through them and do not have a margin problem.

Big investors and brokers who lost money on Monday have been advising the regulator on what could have been done to staunch the panic. This includes impractical ideas like introducing fresh intra-day strike prices for options, which may have only added to the confusion. What they fail to mention is that everybody, almost without exception, advised the BSE and NSE not to reopen the markets after the second circuit break.

Fortunately, the two bourses, after mutual consultation and liquidity promised by the RBI, insisted on re-starting trading. It was a masterstroke, since stock prices retraced nearly 60 per cent of the fall when trading restarted, before drifting lower again. But before the day was out, the panic had ended and it paved the way for a smart rally on Tuesday and Wednesday. This means that although politicians could continue to destablise market with their shenanigans, we can now be confident of a robust trading system.

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-- Sucheta Dalal