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Why do two stock exchanges exist in India?

Prabhat Nigam

| Updated: Dec 01, 2021 | Category: SEBI

Why do two stock exchanges exist in India?

In reality there are more than two stock exchanges that are present in India. These include Bombay Stock Exchange, National Stock Exchange, Calcutta Stock Exchange, India International Exchange (Ind INX), Indian Commodity Exchange Ltd., Metropolitan Stock Exchange Ltd., Multi Commodity Exchange of India Ltd., National Commodity and Exchange Derivatives Ltd., NSE IFSC Ltd.

However given the volume traded in BSE and NSE, these two stock exchanges are considered to be the most prominent two stock exchanges of India. But there is a common misperception amongst people regarding the ownership of these two stock exchanges. They think that the two stock exchanges are owned by the government of India and that they are entities of government of India. In fact both of them are private entities and ownership of both these exchanges comprises a mix of stock brokers, various global and domestic financial institutions, and publicly and privately owned entities.   

What is a stock exchange?

A stock exchange is a platform where investors meet with the company and other investors and buying and selling of securities takes place and the stock exchange charges a certain fee when the transactions take place when its platform is used.

Why the need arose of two stock exchanges?

The Bombay Stock Exchange is considered to be the oldest stock exchange of India when it was started by a group of brokers under a banyan tree and eventually it got established at the Dalal Street, Mumbai in 1874 and was incorporated in the year 1957. It stood as the sole national stock of India back then.

Following are some of the reasons why the need for two stock exchanges was required.

  1. Lack of competition: When monopoly of a certain business entity exists in any market, usually they are only interested to make maximum profits till the time their monopoly exists. Subsequently, they realise that because of their position in the market their customers are dependent on them and have nowhere else to go. Hence, they start dictating their terms and do not pay heed to the demands of their customers. The policies and conduct of business are framed in a certain manner that it suits the needs of the monopoly only. Because no competition existed against BSE back then, BSE dictated terms favourable to certain group and denied fair chances for others. Therefore, in order to increase competition in the market a strong need was felt for two stock exchanges in India.
  2. Charging of exorbitant fees: Being the only platform for trading in securities at the national level back then, fee charged on every transaction made was very high. This made it very difficult for the small investors to save enough on every trade they made. Having another stock exchange would force the other one to offer competitive fee to the investors. The need for competitive pricing was another reason for having two stock exchanges in India.
  3. Lack of Technological upgradation: When an entity enjoys a monopolistic position in the market, it never strives to provide the best of services to its customers. Its services deteriorate day by day and no investment is made to technically upgrade the systems. Such was the case with BSE before NSE came into existence. The settlements were still being done on papers only. In order for the stock exchanges to upgrade themselves technologically and introduce electronic settlement of trades the need for two exchanges was felt.
  4. BSE was controlled by a small group of influential brokers: Since BSE was an owned entity of a small group of brokers back then, they became a powerful and influential lobby that controlled the India’s largest stock exchange. This was seen as a threat by the government and others. In order to break the monopoly of this influential lobby, a need was felt for two stock exchanges in India. 
  5. The stock market was affected by bad deliveries (since everything was done in physical papers only). Instances of delivery of fake certificates were quite common. Further, instances of price manipulation in the market by the brokers were slowly eroding the confidence of the investors in India. A stock exchange having clean and investor friendly business practices bolstered the need to have two stock exchanges in India.
  6. Barriers to join the brokerage community: The rules designed back then were made to favour a select class of stock brokers only. Many barriers were put in place for the outsiders to join the brokerage community and the license for broking was limited to a select class of persons who were usually the sons and relatives of such powerful broking community. To become a broker back then required either connections with the existing brokers or a membership fee of Rs 1 crore which was big sum in 1990s. This kept a lot of people out from the broking community. The need for more transparent and inclusive exchange envisioned the need for two stock exchanges.

Reasons that forced the government to set up two stock exchanges

There were many shortcomings in the existing securities trading business during the 1990s. But following are the trigger points that forced the government to think of coming up with a new stock exchange that not only provides competition to BSE in terms of best practices but at the same time restore the investor confidence in the Indian securities market.

  1. Harshad Mehta scam and a series of other scams: One of the biggest financial frauds in the history of money market took place in 1992 which led to the crash of the stock market. This alarmed the government and made the future of Indian securities market look bleak from investors’ viewpoint. The loopholes within regulatory system; settlement period to be specific was used by Harshad Mehta to make huge profits.
  2. Price manipulations in the market: After the fraud committed by Harshad Mehta came to the forefront, a series of other frauds were also brought to the fore. They were usually committed by the brokers trying to manipulate the prices of the shares. 

All these instances of price manipulations in the market had become too big to be ignored and the government started looking for alternatives to counter the monopoly of BSE in the Indian stock market and this is how the resolve of the government to establish two stock exchanges got firmed.

What took government so long to set up two stock exchanges?

It is wondered that despite so many difficulties existing in the stock market operations, what took the government so long to set up National Stock Exchange in 1992. Following are some of the reasons which can be attributed for the said delay:

  1. Government embroiled in other important issues: Since the government was already involved in many other issues during that period and the then existing framework had been in place for more than a century, it could not envision to engage in the herculean task of reforming a trade practice that had been existing for so long until the Harshad Mehta fraud case emerged. This became a triggering point for the existence of two stock exchanges in India.
  2. Trading community too small to force govt. to make changes: Since the community that was involved in trading was very small, it did not have enough say in order to force the government to introduce changes into the existing scheme of things and seriously thinking of two stock exchanges.
  3. Opposition from influential circle of stock brokers: Since the government was working to break the monopoly held by a small group of powerful stock brokers, the idea of having two stock exchanges was met with stiff resistance from broking community not just from BSE but also from other lobbies controlling the other stock exchanges existing in the country. They felt that their right to carry on business was being curtailed by the government.

Reasons for the success of NSE

The changes and the practices introduced by National Stock Exchange in the securities trading business in 1992 proved to be reformative for the entire industry. Following are some of the reasons that can be attributed for the success of two stock exchanges in India:

  1. Introduction of real time trading with computerized trading: one way in which NSE broke the monopoly of the stock brokers and BSE was bringing in transparency in the system. Earlier the accessibility to stock price information was limited to few brokers but with the advent of NSE, the stock price information was accessible to any person living in the remotest of location. Investors could get involved in real time trading facilities using the computer based systems. With lower accessibility of computer based systems and low computer literacy in India, brokers believed that the NSE would fail. However, the investors received this computer based platform for trading with open arms and forced the BSE to change the methodologies in doing their business.
  2. Entry barriers to become stock broker removed: One of the great steps to increase the inclusiveness in the stock broking community was started with the reforms brought with the establishment of NSE[1]. The earlier criteria of becoming a stock broker was to deposit a membership fee of one crore rupees or on the recommendations of the existing members. This barrier was removed by NSE. Anyone having the required qualification was required to open a non interest bearing account and he could become a stock broker.
  3. NSE gave emphasis to reduce time duration of settlement process: Reducing the duration of settlement cycle was among the prime reason in breaking the hegemony of the BSE in the securities market. The new system introduced by the NSE was reduced to seven days settlement cycle against the fifteen days settlement cycle prevalent in BSE.  
  4. Establishment of National Securities Clearing Corporation Limited (NSCCL): was considered the prime reason for the success of NSE because settlement of all trades started getting done electronically. It became the first clearing corporation in India to introduce settlement guarantee. This was considered to be the masterstroke by NSE to provide security of the investments made by the investors. Initially the investors were a little hesitant with respect to the clearing and settlement of their trades. When later on they saw their trades getting settled without any hiccups, then they were relieved and felt confident to make more investments. Further, the counter party risk guarantee and a tight risk containment system built confidence in the investors with respect to the security of their investment. 

All these reasons of success of NSE stamped the necessity of the idea of having two stock exchanges in India.

Conclusion

Before the introduction of good practices by National Stock Exchange, Indian stock market was ranked at the lowest pedestal across the world because of the inefficiencies and the archaic system of functioning of the stock exchanges. Some even commented Indian stock exchanges belonging to the Stone Age era. Initially investors were sceptical about the success of the electronic settlement of their trades. Once, they saw the results, it started building their trust in the NSE and resulted in the increase in the volume of trade. The initiation of NSE by adopting clean practices forced other stock exchanges to mend their procedures and technologically upgrade themselves to get better than other exchanges. This is how the government by adopting good practices in NSE initiated the culture of adopting clean and investor friendly practices in other exchanges.

Read our article:A look at some of the biggest Financial Scams in India

Prabhat Nigam

Prabhat has done his BA LLB (Hons) and has been writing research papers since his law school days. His interest in content writing made him pursue a career in legal research and content writing. His core areas of interest are indirect taxes, finance and real estate.

Business Plan Consultant


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