RBI's New collateral rule is a 'death knell' for prop trading, warns Crosseas Capital MD

The Reserve Bank of India's new rules for proprietary trading, which came into effect on July 1, are expected to significantly increase funding costs for domestic broking firms and high-frequency traders, according to Rajesh Baheti, Managing Director of Crosseas Capital Services.

Baheti said, “It's the most significant death knell to the prop trading industry since the NSE came into existence.”

Under the revised framework, guarantees used forproprietary trades must now be fully collateralised, with at least 50% of the collateral maintained in cash or fixed deposits. Earlier, brokers could obtain bank guarantees while locking up much less cash, allowing them to operate with higher leverage.

Baheti believes the new framework will make proprietary trading less efficient by increasing the amount of capital that firms must set aside for trading activities.

“If the return on equity goes below a certain threshold, the whole business becomes unviable, considering the risk,” he said.

A central part of Baheti's argument is that the rule falls unevenly on Indian firms. Foreign trading firms and foreign high-frequency traders, he said, can secure funding directly from banks overseas, where the RBI has no jurisdiction. "They will continue to thrive at the cost of Indian firms," he said. "We are exporting our income that will be converted into dollars and taken out of the country."

Asked whether non-bank lenders could step in to fill the funding gap, Baheti said that's not a workaround. Clearing corporations — the entities that guarantee trades on India's exchanges — don't accept bank guarantees issued by non-banking financial companies, he said, so any bank-guarantee-based funding has to come from a bank.

According to Baheti, Indian broking houses and Indian HFTs together account for 30% to 35% of exchange turnover, and that the new collateral rule could reduce that segment's activity by a similar 30% to 35% — translating to roughly a 10% to 12% hit to overall daily volumes.

He also argued that the changes could create an uneven playing field between Indian and overseas firms. While domestic brokers will have to comply with the stricter collateral requirements, foreign trading firms may continue to access funding through overseas banking channels, where financing terms could remain more favourable.

Baheti questioned the rationale behind the RBI's decision, “There's no credit risk. There are no NPAs in the system,” he said while questioning the need for the new restrictions.

For the entire discussion, watch the accompanying video