Badla is a mechanism to avoid the discipline of a spot market; to do trades on the spot market but not actually do settlement. The "carry forward" activities are mixed together with the spot market. Suppose you buy 1,000 shares of Infosys at Rs 3,500, your cash outflow is Rs 35 lakh. Instead of paying cash, you can ask your broker to find a borrower to finance your trade. This process of buying stocks with borrowed money is badla trading.

The stock exchange acts as an intermediary between you and the actual lender. You will be charged an interest rate for borrowing, which will be determined by the demand for that stock under badla trading. Thus, higher the demand for Infosys under badla trading higher will be the interest rate. You can keep your borrowing unpaid for a maximum of 70 days, after which you will have to repay the badla financier through the exchange

Those familiar with futures will immediately recognise its similarity with badla trading. As per single-stock futures, you can buy, say, 10 Infosys futures that will at maturity give you 1,000 Infosys shares on payment of money.

You will initially pay a margin and buy 10 futures contract. This is similar to the broker placing a margin on badla trades. The futures contract will be marked-to-market on a daily basis. This means that if you buy Infosys futures today at Rs 3,750 and the price in the futures market goes up to Rs 3,800 the next day, you will have to deposit with your broker Rs 50 (3,800-3,750) times 10 (the number of futures contract).

You will likewise receive money if the futures price goes below Rs 3,750. Of course, in badla trading, it is the broker who has to maintain a marked-to-market margin and not the buyer/seller as in the case of futures.

In essence, however, both futures and badla system allow investors to buy stocks without huge cash outflow. In other words, both help in leveraged trades. It is also due to this similarity that SEBI has decided to ban badla and introduce futures in line with the trends in developed countries.

Badla is closer to being a facility for borrowing and lending of shares and funds. Borrowing and lending of shares is a functionality which is part of the cash market. The borrower of shares pays a fee for the borrowing. When badla works without a strong margining system, it generates counterparty risk, the evidence of which is the numerous payments crises which were seen in India. Options are obviously not at all like badla. Futures, in contrast, may seem to be like badla to some. Some of the key differences may be summarised here. Futures markets avoid variability of badla financing charges. Futures markets trade distinctly from the cash market so that each futures prices and cash prices are different things (in contrast with badla, where the cash market and all futures prices are mixed up in one price). Futures markets lack counterparty risk through the institution of the clearinghouse which guarantees the trade coupled with margining, and this elimination of risk eliminates the risk premium" that is embedded inside badla financing charges, thus reducing the financing cost implicit inside a futures price

Forward trading was banned by the Central Government through a notification issued on 27th June 1969 in exercise of the powers conferred under Section 16 of the SCRA. As the prohibition of forward trading in securities led to a decline of traded volumes on stock markets, the Stock Exchange, Mumbai (BSE), evolved in 1972 an informal system of "forward trading", which allowed carry forward between two settlement periods, which resulted in substantial increase in the turnover of the exchange. However, this also created several problems and there were payment crises from time to time and frequent closure of the market. During December 1982 - January 1983 the Government reviewed the position and in exercise of its powers under Section 10 of the SCRA amended the bye-laws of stock exchanges to facilitate performance of contracts in "specified securities". In pursuance of this policy the stock exchanges at Bombay, Calcutta and Ahmedabad introduced a system of trading in "specified shares" with carry forward facility after amending their bye-laws and regulations.

The Joint Parliamentary Committee on Irregularities in Securities and Banking Transactions, 1992 (JPC of 1992) discussed the issue of "carry forward of deals" and observed that this system was not functioning appropriately as there werelot of irregularities in the stock exchanges in the form of non enforcement of margins, non-reporting of transactions and illegal trading outside the stock exchange.

SEBI was of the view that carry forward transactions should be disallowed and transactions conducted strictly on delivery basis and trading in futures and options should be permitted in separate markets. Consequently, SEBI issued a directive in December 1993 prohibiting the carry forward of transactions.

However, this was reviewed by SEBI, and pursuant to the recommendations of the G.S. Patel Committee to review the system, carry forward transactions in securities were permitted in 1995 subject to certain safeguards. This was further reviewed by the J.R. Varma Committee report in 1997 and the system was further modified subject to a number of safeguards such as segregation of carry forward transactions at the time of execution of trade, daily margin of 10%, 50% of which would be collected upfront, overall carry forward limit of Rs.20 crore per broker per settlement and other prudential safeguards.

Post-1996, badla existed in different avatars. In 1997, the modified badla system allowed hedging, and had a carry-forward limit of Rs 20 crore per broker. The NSE introduced the Automated Lending and Borrowing Mechanism (ALBM) followed by the BSE's Borrowing and Lending of Securities Scheme (BLESS), which were sophisticated forms of badla. The year 2000, however, was a watershed. The NSE introduced futures contracts on the Nifty. Though this universally-accepted leverage mechanism was available, it did not take off due to the existence of the badla. The abuse of the facility in 2000-01 forced SEBI to ban badla. This move pushed the BSE and market makers also increasingly towards derivatives. The year saw the introduction of options on the index and equity options and futures on individual stocks.

Badla is closer to being a facility for borrowing and lending of shares and funds. Borrowing and lending of shares is a functionality which is part of the cash market. The borrower of shares pays a fee for the borrowing. When badla works without a strong margining system, it generates counterparty risk, the evidence of which is the numerous payments crises which were seen in India. Options are obviously not at all like badla. Futures, in contrast, may seem to be like badla to some. Some of the key differences may be summarised here.

A well functioning spot market has no possibility of carryforward. Derivatives trades take place distinctly from the spot market. The spot price is separately observed from the derivative price. A modern financial system consists of a spot market which is a genuine spot market, and a derivatives market which is separate from the spot market. Badla is therefore banned by SEBI in the stock exchanges of the country, with the advent of trading in derivatives.