'Biggest nightmare': Nithin Kamath warns MTF boom could worsen selloff in small and midcap stocks

Zerodha co-founder Nithin Kamath has warned that the rapid growth of margin trading funding in India could become a major risk for brokers and investors if markets see a sharp fall, especially in small- and mid-cap stocks. In a post on X, Kamath said his "biggest nightmare as a broker" is what is happening in Korean markets, where a sharp rally and rising leverage have increased the risk of forced selling when prices reverse.

Kamath said the concern comes from the way Zerodha’s margin trading funding, or MTF, book has grown along with the rest of the industry. MTF allows investors to buy shares by borrowing part of the purchase amount from brokers, using securities or cash as margin.

"In terms of pure risk, MTF is by far the biggest risk we have taken since we started in 2010," Kamath said.


He said Zerodha's MTF book stands at about Rs 9,000 crore. At least half of this exposure is in non-F&O stocks, which makes the risk sharper because these shares can hit lower circuits every day and may not give investors or brokers an easy exit.

That is the main worry. In highly liquid largecap derivatives stocks, forced exits are easier. In non-F&O small- and midcap counters, a falling market can freeze liquidity. If a stock hits lower circuit, sellers may not find buyers. That can turn a normal margin call into a bigger risk for brokers.

Also Read: Adani Enterprises Q1 Results: Co reports loss of Rs 1,160 cr on one-time expense; revenue surges 50% YoY

Leverage can feed both rallies and crashes

Kamath said the problem in Korea is the one-way rally. When markets rise sharply, collateral values increase. That allows investors to borrow more. More borrowing then feeds more buying, pushing prices higher again.

This loop can work well when prices are rising. But it turns dangerous when the market falls.

"When the markets fall, things get really ugly," Kamath said. He explained that the first leg of selling is usually small. But as prices fall, collateral and margin values drop. That triggers margin calls. Investors then have to bring in more funds or brokers are forced to sell their holdings.

This forced selling can pull prices down further. The fall can then trigger more margin calls, creating another round of selling.

Kamath said derivatives and leveraged exchange-traded funds can make this worse because they can amplify both upward and downward moves. In a falling market, forced unwinding from leveraged products adds more pressure and creates a self-reinforcing loop until the market stabilises.

Smallcap risk under watch

Kamath said MTF became popular only in the last three to four years, and India has not seen a sharp crash like the COVID selloff during this period. Even though MTF is still small as a percentage of total market capitalisation, he warned that a sharp fall in Indian equities could cause severe selloffs across many small- and mid-cap stocks.

Brokers typically offer MTF on about 1,500 stocks, he said. That wide coverage means leverage is no longer limited to only the most liquid names. The warning comes after a strong run in several pockets of the Indian market, especially smaller companies, where retail participation has stayed high. A large part of the concern is not just falling prices, but the speed at which leverage can unwind when too many investors are forced to sell at the same time.

Kamath said India has avoided the worst excesses of unchecked leverage because of SEBI’s regulatory framework.

"Luckily, thanks to Sebi, we've avoided the worst excesses that typically arise from unchecked leverage,” he said.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)