The badla system -- which means something in return -- satisfies three needs of the market. Firstly, if investors feel that the price of a particular share is expected to go up or down, he could participate in the possible fluctuation of the share, without giving or taking delivery. Secondly, if the investor wishes to go short on a particular scrip but without owning the security, the stock lender enters the carry forward system and lends his stock for a charge.

Thirdly, if the investor wishes to buy the share without paying the full consideration, the financier steps in and provides the finance to fund the purchase.

Typically, the system facilitates an individual to buy or sell shares on the stock exchange in the settlement cycle (which usually lasts for five days). At the end of the cycle, he must either deliver the shares sold, or pay the money for the shares purchased.

The alternative is using the badla mechanism. This mechanism is available only for 150 stocks that are traded in the specified or A group on the BSE. For the amount of shares that the investor has purchased, he pays a certain amount; it is usually 15 per cent by way of margin.

How vyaj badla works
A vyaj badla is a two-way transaction executed simultaneously. The first phase of the trade is a purchase transaction at the closing price of the share in the current settlement (trading cycle on the stock exchange). The second phase involves the sale transaction at the closing price plus badla or the financing charges in the next settlement. The carry forward session is held at the end of each settlement (on Saturdays).

As far as the financier is concerned, his money is invested on the exchange for a settlement of five days. The rate of badla that a financier earns depends on what the demand-supply situation of the funds available is in that particular settlement period.

The financier gets custody of the shares against the amount lent by him. Sebi mandates that these be kept in the safe custody of the clearing house until the 'vyaj badla' is released, and the investor wants his funds back.

It is also possible to open a sub-account in the investor's name in the clearing house so that the shares remain in his name and the same cannot be misused. In fact, it is not necessary to have the shares in his sub-account. He could exercise his lien based on the contract given by the broker.

The badla system then is kind of a future. But, it has its own limitations. Institutional players namely the financial institutions (FIs) and financial institutional investors (FIIs) are not allowed to participate.

The market rates are driven and dependent on the supply and demand in the market. In a rising market, the badla rates are naturally high. The badla rate for a scrip is determined during the badla session, which takes place between two settlement periods. The rates are typically a function of the interest rate in the economy, overall need for funds in badla and, the short/long position in a scrip.

The carry forward system is necessary to cater to the three needs mentioned above. The hedging mechanism may also be provided by introducing options and futures, banks becoming liberal and lending against shares and, lastly by setting up a stock lending system. If these requirements are met, the carry forward system will die a natural death.