This week's small-cap rout was a warning. SEBI should rein in borrowed money before it lets brokers lend more

On Friday the Nifty Smallcap 100 fell as much as 3.8%, capping a week that took 7.4% off the index. The Sensex and Nifty 50 fell less than 1%. The independent market expert Ambareesh Baliga put his finger on why: the sell-off “is not about the valuations, and more about margin calls, which have been hitting retail investors.”

That is a warning worth taking seriously, because the amount of borrowed money in Indian shares has grown much faster than the rules meant to contain it.

How big the borrowing has become

Leveraged equity positions stood close to a record ₹1.6 lakh crore on 30 September. The NSE’s margin trading book alone was ₹1,22,151 crore in May, several times what the industry’s book was in early 2022. About half of that NSE book sat in shares outside the futures and options segment, which tend to be smaller and less easily traded. Brokers have funded the boom partly with short-term borrowing: they raised about ₹3.2 lakh crore through commercial paper this year, around 21% of all such issuance, up from about 4% in 2021. Clients pay roughly 9% to 20% on the loans.

The people running this business have said openly that it worries them. Nithin Kamath, co-founder of Zerodha, warned in May that “if markets crash, brokers could end up holding losses from MTF positions they can’t exit.”

The danger is a spiral. When the shares bought with a loan are also its security, a fall in price triggers margin calls, the calls force selling, and in a thinly traded small-cap stock that selling drives the price lower still. If a stock hits its lower circuit, nobody can get out at all, and the loss moves from the client to the broker and from the broker to its lenders.

The fair objection

The margin trading facility is regulated, backed by collateral and reported to the exchanges. Adults are entitled to borrow to invest, and many do so sensibly. A one-week fall in small caps, after a long rally, is not a crisis, and heavy-handed rules could push traders into riskier products such as options.

All true. The case for caution rests on something narrower: matching the rules to where the leverage now sits.

What SEBI should do

SEBI’s consultation paper of 18 June was mostly about plumbing. It would raise the minimum net worth for brokers offering the facility to ₹5 crore, but it would also let them lend up to 5.5 times their net worth and fund the book by issuing bonds. To its credit, SEBI refused calls to cut the extra margin that guards against the risk of a stock serving as security for its own purchase. Before it finalises anything that lets brokers lend more, it should do four things.

First, publish the data. Exchanges should release, every week, the size of the margin book by stock and by category, so investors and analysts can see where leverage is piled up.

Second, set higher margins for less liquid shares. A stock that trades thinly and has no futures contract should need a bigger down payment than a large company, whatever its volatility formula says.

Third, cap concentration. When a large share of a small company’s free float is held on borrowed money, new margin lending in that stock should stop.

Fourth, test the brokers. SEBI and the RBI should check how large brokers would cope if a sharp fall coincided with tight short-term funding markets, since commercial paper must be rolled over in exactly the weeks when markets are falling.

Borrowing to buy shares has its place. The system built around it has not yet been tested by a real crash, and the regulator should not wait for one to find out where it breaks.

The reporting behind this view

• 7.4%weekly fall in the Nifty Smallcap 100 to 23 October 2026
• ₹1.6 lakh croreleveraged equity positions on 30 September 2026, close to a record
• 21%brokers' share of commercial paper issuance in 2026, up from about 4% in 2021