Synopsis: Zerodha co-founder Nithin Kamath warned that rising MTF exposure in illiquid mid and small-cap stocks could amplify broker and systemic risks during market corrections, especially as leverage builds despite stagnant broader market conditions.
Zerodha co-founder Nithin Kamath recently highlighted concerns about the rapid rise in Margin Trading Facility (MTF) exposure across Indian brokerages. In a post on X (formerly Twitter), he warned that even though broader markets have remained largely flat, leveraged positions in MTF, especially in illiquid mid and small-cap stocks are expanding quickly.
He contrasted this with past global examples where leverage was built during strong rallies, emphasizing that India’s current risk buildup is happening in a sideways market, which can be more fragile during sudden corrections.
Margin Trading Facility (MTF) Growth in Flat Markets
Margin Trading Facility (MTF) has been expanding across brokers even in a sideways or low-return market environment. This is because MTF growth is primarily driven by leverage demand rather than strong market direction.
Investors use borrowed funds from brokers by pledging cash or shares, allowing them to take larger positions than their capital would normally permit. For brokers, this becomes an attractive business line since it generates interest income and increases trading activity even when market indices are not moving much.
Liquidity Risk in Falling Markets
The biggest structural risk in MTF is the illiquidity that appears during sharp market corrections. When stock prices fall beyond margin requirements (typically around 15–20%), brokers are required to square off positions.
However, in stressed markets, especially for small and mid-cap stocks, liquidity can disappear quickly. Many such stocks also hit lower circuit limits, preventing free trading. This creates a situation where brokers may be unable to exit positions even when risk systems demand liquidation, increasing the chance of losses sitting on broker books.
Collateral Leverage and Risk Amplification
Risk increases further when investors use pledged stocks as collateral to take additional leveraged positions. For example, an investor may pledge Stock A, receive up to ~80% margin, and then use that borrowing to increase exposure significantly, sometimes even in the same stock. If the stock declines sharply, both the collateral value and the open positions fall simultaneously, creating a cascading risk effect. With nearly half of industry MTF exposure concentrated in non-F&O stocks, the risk is higher because these stocks tend to be more volatile and less liquid during downturns.
Broker Exposure and Credit Risk Concerns
From a broker’s perspective, MTF introduces both market risk and credit risk. Market risk arises when positions cannot be liquidated in time due to a lack of buyers or circuit limits, while credit risk arises when customers are unable to repay shortfalls after liquidation. In extreme scenarios, brokers may be forced to absorb losses if client recovery fails. In some cases, MTF exposure can become very large relative to a broker’s net worth, increasing systemic vulnerability during market stress.
Although MTF appears to be a steady income generator in normal conditions, it carries asymmetric risk. Profits accrue gradually, but losses can be sudden and large during market shocks. This is why broker risk management teams impose strict controls such as margin monitoring, collateral haircuts, and forced liquidation triggers.
The key challenge is balancing competitive pressure to grow MTF books with the need to ensure that a sharp market downturn does not destabilize broker balance sheets or the wider financial system regulated by SEBI.
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