Zerodha founder and CEO Nithin Kamath has issued a stark warning regarding the potential for a South Korea-style market meltdown in India, citing the rapid growth of margin-funded investing as the 'biggest risk' facing the Indian equity market. Kamath's concerns come after South Korea's benchmark Kospi index experienced a significant 6% plunge, triggered by disappointing earnings from semiconductor giant SK Hynix.
While the initial trigger for the Korean selloff was earnings, Kamath emphasized that the sharp decline was amplified by excessive leverage within the market. He believes this highlights a crucial lesson for India, whose rapidly expanding Margin Trading Facility (MTF) market has yet to undergo a true stress test in a severe market correction.
Leverage: A Double-Edged Sword
Kamath described the unchecked expansion of margin-funded investing as his "biggest nightmare as a broker." He explained how leverage can fuel a bull market, as rising collateral values allow investors to borrow more, creating a self-reinforcing cycle of buying. However, this process reverses dramatically during a downturn.
"My biggest nightmare as a broker is what’s happening in the Korean markets right now. The source of my nightmare is the way our MTF book has been growing along with the industry as a whole," Kamath stated, highlighting Zerodha's own MTF book of approximately ₹9,000 crore, with nearly half exposed to non-F&O stocks.
When stock prices fall, collateral values decrease, leading brokers to issue margin calls. If investors cannot meet these calls, brokers are forced to sell pledged securities, flooding a falling market with supply and accelerating the decline. This forced selling, particularly in illiquid segments, can create a vicious cycle that quickly turns a correction into a crash.
India's Untested MTF Ecosystem
Kamath noted that India's MTF ecosystem has gained significant traction only in the last three to four years and has not yet faced a market crash comparable to the recent Kospi plunge since the COVID-19 pandemic. While margin-funded positions are still relatively small compared to India's overall market capitalization, he warned that a sharp correction could lead to disproportionate selling, especially in small- and mid-cap stocks.
A critical vulnerability, according to Kamath, is that many non-F&O stocks, which constitute a substantial portion of some MTF exposures, can hit consecutive lower circuits during panic, trapping investors and brokers. With brokers now offering MTF across nearly 1,500 stocks, a broad market decline could trigger widespread forced unwinding.
SEBI's Guardrails Offer Some Comfort
Despite his concerns, Kamath acknowledged the proactive measures taken by the Securities and Exchange Board of India (SEBI) to mitigate excessive leverage. Over the past few years, the regulator has tightened peak margin requirements, strengthened risk management norms, and imposed stricter rules around margin funding. These guardrails, he believes, have prevented the kind of unchecked leverage seen in some international markets.
Although the Korean market's sharp fall doesn't guarantee an imminent meltdown in India, Kamath's warning serves as a crucial reminder. As leverage becomes more integrated into the cash market, India's margin trading ecosystem may face its most significant test during the next major market correction.