RBI's New Rules on Exchange Guarantees Worry Proprietary Traders

About ₹1.2 trillion in bank guarantees sit on the books of Indian stock exchanges today. That is not a trivial number. It is the financial scaffolding that keeps a large chunk of daily trading moving on the National Stock Exchange and the Bombay Stock Exchange. And right now, the Reserve Bank of India wants to change how that scaffolding is built.

Brokers who trade using their own money, a category the industry calls proprietary traders, met Reserve Bank of India officials on Wednesday to make a case. Their message was straightforward: not everything that looks like a bet is actually a bet. The RBI heard them out. It made no promises.

The meeting was arranged by the Association of NSE Members of India, the body that represents brokers on the National Stock Exchange. What brought everyone to the table was a circular the RBI had issued on 13 February this year, one that tightened how banks can support proprietary trading activity. Under the new rules, any bank guarantee extended to exchanges or clearing corporations on behalf of proprietary traders must be fully backed by cash, government securities, or their equivalents, with at least half of that in actual cash. That sounds like a small technical detail. For the firms involved, it is anything but.

Currently, proprietary trading firms put up a relatively small amount of cash as margin and pair it with personal or corporate guarantees to unlock much larger bank guarantees. The RBI’s new requirement would force them to lock up significantly more capital just to maintain the same level of market access. The brokers’ body says the ₹1.2 trillion in outstanding bank guarantees across exchanges, as of February-end, gives a sense of the scale.

So why did the RBI move in the first place?

The central bank ran an inspection of certain private banks and their exposure to capital market intermediaries. What emerged, according to people familiar with the matter, was a pattern: the same set of proprietary traders had gone to multiple banks, each time applying for guarantees. The combined exposure built up quietly, with each individual lender perhaps unaware of how many others had similar commitments to the same set of firms. The RBI’s concern was clear. Public money, mobilised through bank deposits, was finding its way into equity markets, particularly the derivatives segment, where trading can get highly speculative.

That concern has a real-world basis. Proprietary traders are enormous players in Indian markets. In the equity derivatives segment of the National Stock Exchange, proprietary traders accounted for 59.26 percent of total turnover in the financial year just ended. In the cash segment of the NSE, they held a 30.9 percent share. On the BSE cash segment, the figure was 36.9 percent. These are not niche players. They sit at the heart of how Indian markets function every day.

The brokers’ counter-argument runs like this: proprietary traders do not simply place one-way bets on whether Infosys will rise or fall. A significant part of what they do is market-making, which means they simultaneously offer to buy and to sell the same security, earning a small spread on each transaction while ensuring that anyone who wants to enter or exit a position can actually find a counterparty. Remove that function from the market and liquidity suffers. When liquidity suffers, bid-ask spreads widen. When spreads widen, ordinary investors and even large institutions pay more to execute every trade.

The association also raised the matter of spread trades, positions that are offsetting by design, meaning the risk on one leg is balanced by the risk on another. These, the brokers argued, are hedges, not speculative positions. The RBI’s response was careful: defining what counts as speculation and what counts as hedging is not its job. That is work for the Securities and Exchange Board of India, the markets regulator. The RBI sets rules for how banks extend credit. What the borrower does with that credit is, to a point, outside its remit.

That reply effectively kicked the definitional question to SEBI, and the timeline gets tighter by the week. The RBI had already deferred enforcement of the February circular by three months, pushing the effective date to 1 July. That extension expires in less than two months. No indication has come that a second extension is on the way.

What does this mean for retail investors and ordinary market participants?

The short answer is that less proprietary trading activity likely means slightly less efficient markets. The tighter spreads that retail investors have grown used to, especially in highly traded index derivatives, exist in part because proprietary firms compete aggressively to provide those prices. Pull back that activity and you may not notice it on day one, but over time, transaction costs can drift up.

There is also a second-order effect worth watching. Proprietary firms take on risk that hedgers, including fund managers and large corporations, want to offload. If funding constraints push some of these firms to reduce activity, institutional hedgers face a thinner market. That can push up the cost of hedging, which eventually shows up in fund expenses.

The broader question the RBI is grappling with is legitimate: how much bank credit should flow into equity markets, and under what conditions? Banks mobilise savings deposits from crores of ordinary Indians. Using those to back large market positions creates a link between the financial health of trading firms and the safety of depositors’ money. The RBI has seen enough crises globally to take that link seriously.

Whether the solution is to require more cash backing or to find a smarter way to cap aggregate exposure across lenders is still an open debate. The outcome of that debate, expected to become clearer by July, will set the tone for how India’s most active market participants operate for years ahead.

For retail investors, watching this space matters. Not because proprietary trading affects their savings directly, but because the depth and efficiency of markets that they invest in every day depends on it.