Zerodha's Nithin Kamath Warns of Structural Risks in Rs 1.10 Lakh Crore Margin Trading Boom

Zerodha founder and CEO Nithin Kamath has issued a stark warning about mounting structural risks in India's equity markets, highlighting concerns over the explosive growth in margin trading facilities (MTF) that could amplify market stress during the next significant correction. In a detailed analysis shared on social media platform X, Kamath flagged the rapid expansion of MTF as a potential systemic risk that lacks adequate risk management frameworks.

Explosive Growth in Margin Trading

The margin trading facility market has witnessed remarkable expansion, growing nearly five-fold over the past four years to surpass Rs 1.10 lakh crore. This growth has particularly accelerated following the imposition of higher margins and securities transaction tax (STT) on derivatives trading, which has pushed leveraged trading activity into the cash market segment.

MTF allows investors to purchase shares by paying only a portion of the total value upfront, typically 20.00 to 25.00%, with brokers funding the remaining amount. Unlike derivatives where positions are marked to market daily and are typically short-term, MTF positions can be held for extended periods, making risk accumulation slower but potentially more severe.

Systemic Risk Concerns

Kamath's primary concern centers not on the existence of MTF itself, but on the absence of robust, system-wide risk models governing how these facilities are offered and managed. He argues that competitive pressures among brokers have created a "race to the bottom" scenario, where virtually every firm offers the maximum leverage permitted by regulations to avoid losing market share.

The Zerodha CEO highlighted several risk multipliers that distinguish MTF from traditional futures and options trading:

• Extended holding periods: Clients tend to maintain positions for months rather than days
• Broad stock coverage: Leverage available across nearly 1,300 stocks, including many illiquid names
• Directional bias: Positions are overwhelmingly on the buy side
• Limited risk management: Harder to manage downside risk during market stress

Layered Leverage Amplifies Risk

Kamath described what he termed "insane" leverage scenarios when stocks are accepted as collateral. He provided a specific example illustrating the compounding risk: an investor holding Rs 1.00 lakh worth of shares could receive collateral margin of approximately Rs 80,000.00 after haircuts. This collateral can then be utilized to establish MTF positions worth up to Rs 5.00 lakh, creating layered leverage that significantly magnifies potential losses during market downturns.

Liquidity Concerns and Market Dynamics

The Zerodha founder warned that Indian equities typically exhibit strong liquidity during bull markets, but this liquidity evaporates rapidly during market corrections. With limited short-selling mechanisms through securities lending and borrowing (SLB), natural buying interest often disappears when markets reverse direction. This dynamic could make forced liquidations self-reinforcing, particularly affecting stocks outside the top 200 to 300 by liquidity.

Regulatory Framework and Gaps

While SEBI has implemented caps limiting MTF exposure to 50.00% of a broker's net worth plus borrowings, or up to five times net worth, Kamath argued these measures primarily protect against broker-level failures rather than widespread client defaults during sharp market corrections. He noted that India has not experienced a major market shock comparable to 2008, 2015, or the COVID-19 crisis since MTF scaled to its current size.

Market Stress Testing Concerns

Kamath expressed particular concern about the untested nature of current MTF systems during severe market stress. He warned that when a significant market shock occurs, synchronized liquidations could trigger cascading price declines, especially in less liquid securities. The absence of comprehensive risk models means the industry is essentially "praying that stocks don't fall" rather than implementing robust risk management frameworks.

The Zerodha CEO concluded that a substantial portion of interest income and capital earned by brokers during the current boom phase could be eliminated during a fast, disorderly market correction, highlighting the need for more sophisticated risk management approaches in the rapidly expanding MTF segment.