Chapter-2

Role of Retail Investors in the Capital Market

2.1 About Retail Investors

2.1.1 Introduction

Retail investors are considered as the backbone of the Indian economy. They play a
prominent role in the capital market along with the foreign institutional investors and
domestic financial institutions. Their contribution towards the capital market
especially after the introduction of financial reforms in India needs to be studies
thoroughly. This chapter is an attempt in that direction. The role of regulatory
authorities to safeguard the interests of the retail investors has also been studied.

The entire gamut of securities markets revolves around the three broad components
i.e. issuers of the securities, intermediaries and investors. However, the present study
focuses on the investors’ component investor only. There are mainly three categories
of investors in markets, viz. retail investors, institutional investors, and non-
institutional investors. Other categories of investors include qualified institutional
buyers (QIBs) and non-institutional investors. QIBs comprise the following:

1. Mutual Funds
2. Scheduled Commercial Banks
3. Public Financial Institutions as specified in Section 4(A) of the Companies
Act, 1956.
4. Development Financial Institutions
5. Pension and Provident Funds
6. Foreign Institutional Investors
7. Venture Capital Investors
8. Venture Capital Funds
9. State Industrial Development Corporations
10. Insurance Companies.

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Non-institutional investors include the following:

1. Hindu Undivided Family (HUF) in the name of Karta

2. Corporate bodies
3. NRIs
4. Scientific Institutions
5. Societies & Trusts.

Investors support the development of economy by mobilizing their surplus resources

through the capital market and other means of investments. The retail investors
assume greater significance because the household savings account 30% of Gross
Domestic Savings and it is the prime source of funding. The retail investors stay for a
longer period and this provides the stability to the markets. But, it is deplorable that
the household investors park their savings only 2% to 3% in capital market, and put
their major chunk of money in other class of assets, perhaps because they have burnt
their fingers in the market scams, manipulations and also on account of the higher
volatility.

As per RBI data, the retail investors have put in around 2% of their savings in capital
market (RBI, Economic Review, 2009). There is urgent need to look into the causes
and to take remedial actions, if we expect consistent double-digit growth in GDP.
There is need to increase the retail investors’ participation, and this could be done by
increasing the financial literacy and awareness, expanding the number of issues,
providing diverse investment options, training and increasing the reach of
intermediaries, enhancing investor protection measures, simplified norms and cost
effective services (Rai, 2010). On the other hand, Kannadhasan (2011) while debating
on the growth of retail investors, states that according to SEBI statistical records, it
shows that the Retail investors’ contribution towards the capital market has increased
due to globalisation and the investors’ awareness.

Venkateshwaran (2011) is of the view that the development of the securities market
brings in a host of benefits, including the creation of more complete financial markets,
facilitating financial disintermediation and risk diversification, financing of the
government deficit, smooth conduct of the monetary policy, stabilization of capital

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inflows and product innovation. There is need to have a comprehensive data and
relevant information from the regulated entities for incorporation in the flow of funds
accounts. Black, (2008) is of the view that policy-makers should view investor
education as an important aspect of fairness and the regulator must “encourage and
promote informed investment decision-making” as one of the main goals. According
to her, it is unfair treatment if investors participate in markets about which they lack
the necessary education. Investor education becomes particularly important with the
increasing variety of investment products of greater complexity. In addition, many
retail investors make their investment decisions based on recommendations from
brokers. In most of the cases, these recommendations prove harmful to retail
investors. Thus, investors need education about basic investment theory so that they
can understand and assess their advisors’ recommendations. The retail investors are
having a mix of the objectives i.e. regular income, value appreciation, Liquidity or
Marketability and most important safety & security (Kannadhasan 2011).

2.1.2 Who is a retail investor? Who comes under the purview of a retail
investor?

In accordance with SEBI (Disclosures of Investor Protection) Guidelines {DIP

Guidelines}, a retail individual investor is defined as the one who applies or bids for
securities of or for a value not exceeding 1 lakh as against the earlier limit of
50,000. However, SEBI has since increased the limit for retail investors to 2 lakh
(SEBI Circular, 2010). The word “applies or bids” means the investor can invest in
primary market through an IPO application or in mutual fund or in secondary market
by bidding through a broker/sub-broker. The definition as given in DIP Guidelines
appears to be vague, as it does not specify whether the value is the face value or the
offered value including premium. But, for the present study, the individual investors
who hold shares not more than 20 lakh of face value as their investments are taken
into consideration.

2.1.3 Retail Investors: Backbone of Indian Economy

Investors are the backbone of any securities market as they are the prime constituents
and the key players in the financial system. No study about the securities market will
be complete without the mention of investors and shareholders/ stakeholders

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particularly the retail investors. As discussed in the previous chapter, both the
business houses and government look towards investors for raising money in order to
meet their need for funds for short-term and long-term development projects. A sound
and vibrant industrial system is a prerequisite for strong economy of any country.
Investors are providers of the much-needed finance for a strong economy. Hence, it
becomes duty of the market regulator and other intermediaries to protect the interests
of the investors. Retail investors are advised to trade with abundant caution and with
limited amount of capital on which they can take risk. They should trade with
discipline and should know what they are doing in the market (Angel, 2007).

2.1.4 Importance of Retail Investors for Capital Market

There are talks at global level to protect the interests of investors particularly retail
investors, because it is the investors who build the stock market and the economy of
any country. Retail investors look for long-term investment, but on the other hand
FIIs, FFIs, QIBs and HNIs play for short-term gains. If the government and its
various agencies are able to look after the interests of retail investors, the corporate
houses and government will be assured of long-term finances for building up the
economy. History is witness to the fact that stock markets of those countries have
grown at a much faster pace, which have taken care of investors, particularly the retail
investors. Higher the investors’ confidence, more are the chances of putting their
savings in the productive channels. In other words, the capital formation takes place
at a faster pace where investors’ interest is taken care of. Individual investors have
become far more powerful than anyone gives credit. Bartimoro (2010) states that
today 85% Americans invest in stocks. Collectively, that kind of buying and selling
power can move markets. This is the market we wish for Indian Securities Market.

There is a growing concern about the safety and integrity of capital market at the
international level. The global concern is to make the stock markets safer, transparent
and devoid of frauds and scams. Today, Indian securities market is of one of the most
robust and vibrant securities market in the world. India has latest technology, shortest
settlement cycle, paperless transaction and screen based trading system, better
corporate governance norms and faster dissemination of information.

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However, if we look at the participation of retail investors in Indian securities market,
the picture is not at all comparable with global statistics. The retail investors have
preferred to stay away from the securities market and have preferred to invest their
hard-earned money in other safer modes of investment like bank deposits, Insurance
products, mutual funds, gold, real estate, etc. Price manipulation, increased volatility,
repeated scams, ineffective corporate governance norms, etc. have been the main
reasons for keeping the retail investors away from the securities market. A wide
investor base is always in the interest of Capital markets. It helps in checking the
volatility, deepening of the markets and reducing the cost of transactions
(Neelakantan, 2010). Thus, there is an urgent need to take care of the interests of
retail investors if we wish to have a strong and robust economy.

2.1.5 Investors and their Expectations

The investors predominantly look forward for following three objectives while
investing their hard earned money:

1. Safety of the invested money,

2. Liquidity of the instruments invested, and
3. Return on the investment.

Once the investors are sure of meeting of above-said three objectives, they invest their
money without worry. Thus, these three factors must be taken care of, if we wish for a
robust and vibrant securities market in the country. The securities instruments are the
most rewarding as well as challenging. The products are complex but offer unmatched
returns.

A sound and vibrant securities market ensures that there is a free flow of funds to the
corporate houses and government, and at the same time it ensures that the interest of
investors is taken care of so that there is safety of their investments and they are able
to derive handsome returns. There arises a need to strike a balance between raisers of
capital and the interest of investors. Unless and until, we are able to protect the
interest of retail investors, the corporate houses would find it very difficult to raise
money over a very large period of time. But at the same time investors are advised not

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to trade in the markets based upon the recommendations of the brokers etc., rather
they should do their own study, if they wish to succeed (Bernstein, 2007). The
investors are also advised to have a long-term horizon in the markets and should not
look for quick fixes. Investors are advised to have a long-term horizon on floor and
there are lot of months the investors grind it out and they will have a few glorious
months (Chandra, 2007). The interest of small or retail investors should properly be
taken care of, as the higher the degree of protection to retails investors, higher will be
standard of capital market of an economy as well. It is an indicator of capital market
stability and for economy. A capital market where retail investors’ interest is not duly
taken care of can never be said to a stable one.

2.1.6 Efforts made for the Growth of Retail Investors

SEBI has initiated a number of steps to boost the participation of retail investors.
Following factors have culminated in emergence of retail investors and their greater
participation in securities market:

1. Nation- wide access of trading terminals of BSE and NSE,

2. Stronger Corporate Governance norms,
3. Increased participation of retail investors in IPOs,
4. Stipulation of minimum public shareholding,
5. Launch of various schemes by Mutual Funds for retail investors,
6. Introduction of shorter settlement cycle,
7. Demat of shares,
8. Increase in minimum public shareholding, and
9. Application supported by Blocked Amount (ASBA).

The above-said measures have brought retail investor to the forefront of Indian Stock
Market and their contribution can be gauged from the fact that Reliance Industries
Limited alone has 35 lakh retail shareholders or investors and the company has risen
to the greater heights due to the large participation of retail investors.

Many top industrial luminaries like late Mr. Dhiru Bhai Ambani and Late Mr. J.R.D.
Tata had great faith in Indian retail investor, and companies of these luminaries

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created world class Business Empire just by motivating the retail investor to invest in
their business ideas and thereafter sharing the wealth with them. They were of the
view that true spirit of corporate democracy comes from participation of retail
investor, which in turn leads to the overall growth of the economy or an enterprise.
The small money pooled from millions of investors makes it big for companies and
helps them realize the potential, which is quite evident from the mutual funds and
their collections (assets under management). However, the fact remains that despite
above-said measures initiated by SEBI and by the few of top corporate luminaries, the
population of retail investors has not increased to the desired level.

2.1.7 Foreign Institutional Investors: Impact on Indian Capital Market

In the recent years, Indian Capital Market has witnessed that Foreign Institutional
Investors are becoming major participants in the Stock Markets. They have a global
investment perspective and independent country market evaluating criteria. The basic
concern in this context is generating faith in Indian markets, which requires our
market intermediaries to become more transparent, more informative and encourage
greater participation from the institutions and the individuals. Better-educated and
empowered investors play their role in stabilizing the market which itself generates
faith among the investors who are looking forward for better investment
opportunities. These investors too strongly influence the national economy. The
growth of institutional investors in the market is having its own advantages as well as
it brings its own share of problems. The participation by the bigger players in the
market causes the market to deepen and reduce the cost of transactions. Also, the
increasing presence of this class of investors leads to reforms in securities trading and
transaction systems, nurturing of securities brokers, and liquid markets. If we see the
number of FII flows into Indian Capital Market, it is increasing every year with
substantial percentage, which has led to globalization of Indian Securities Market.

Foreign investors in particular bring a very much-required welcome inflow of foreign

capital, but there are always some dangers if certain limits are exceeded. Firstly, the
foreign investors are free and unpredictable and are always on the lookout of profits.
FIIs frequently move investments, and those swings can be expected to bring severe
price fluctuations resulting in increasing volatility and instability. This is the way the

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FIIs are supplementing volatility in the Indian market. This is what is happening in
current scenario. Increased investment from overseas is likely to shift control of
domestic firms to foreign hands. This shows us how the Indian market is
interdependent on global markets like U.S., Europe and other Asian markets. Any
meltdown in these markets would cause them to sell in Indian markets resulting in
sudden downslide and panic. The sell off by FFIs and FIIs also triggers the sell wave
by other investors and that causes markets meltdown and sudden erosion of investors’
wealth. Rekha and Dutta (2009) are of view that it is extremely difficult to say what
can be the investment behaviour of the FIIs in the equity markets.

While promoting induction of FIIs in the Indian Capital Market, the interest of retail
investors can never be ignored (Bhatnagar, 2010). Volatility emerging out of
investment and disinvestment by FIIs ultimately affects the financial health of the
Retail and Small investors. Markets are skewed towards the institutional players and
that is why retail investors are staying away. The much hyped NTPC (Indian blue
chip PSU with strong fundamentals) could manage only 1.2 times in its follow on
offer with retail participation of only 16% with only 80,000 applications throughout
the country (Dalal, 2010). The major challenges for growing the retail investor base
in India is due to lower risk appetite & expectations of the guaranteed returns, lack of
distribution reach in smaller cities, low awareness & confidence, short-term horizon
and regulatory conflicts (Nath, 2010).

2.2 Investment Process and Retail Investors

2.2.1 Process of Investment

A prudent retail investor passes through various stages for taking an investment
decision, while an ill informed retail investor simply ends up with the decision on the
basis of rumours, tips, without any scientific decision-making process and most of the
decisions are taken instantly without any study. It is observed that they are not fully
educated and not aware about the scientific process of investment and various
investment avenues. Lack of awareness on the part of investors, leads to ill informed
investment decision and it consequently leads to financial losses. The globalization of
financial markets has made investors’ decisions complex (Bennet and Selvam, 2011).

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Research by behavioural finance experts has shown that investors’ financial decision-
making is not always driven by just mental considerations. The investors have
revealed more human traits in investment decision-making such as fear, greediness,
risk seeking and aversion, peer group pressures and pleasure rather than going in a
systematic manner.

Psychological and behavioural factors play a vital role in investment decision rather
than fundamental analysis of facts and figures. It is a well-known fact that the ability
of human beings to make complex decisions is limited and emotionally and
psychologically biased (Kannadhasan, 2011). Similarly, Tom Bierovic (2007) advises
the investors not to get overly excited about winning trades and do not get overly
despondent about losing trades… you should not feel like a hero after one winning
trade and you should not feel like a bum after losing a trade.

2.2.2 Well-informed Investor

A well-informed investor makes his investment decision based upon sound reasoning
and after taking into consideration many parameters. These parameters could be, what
should be his investment objective, why should he invest, when should he invest,
what are his investment options, what care he should take while making investment
and what should he do if he has any grievances (SEBI, Publications on Investor
Education).

A well-informed investor trades based on the well-defined parameters and he never

invests his 100% money in stocks. He diversifies his portfolio, he always keeps watch
over general market conditions, he never lets his emotions prevail over a rational
disciplined approach, he uses right techniques and he expects the stock to be volatile
and there will always be probability that something may go wrong suddenly
(Shamatov, 2009). According to Simha (1998), investment decision-making in equity
shares is a complex business, requiring the detailed study, deep thinking, consultation
with experts and a little luck too. An intelligent investor puts various questions to self,
his peers, market experts, and then tries to find the answers before taking an
investment decision. He makes in depth study before making any investments in any
king of instruments. The various questions and their possible answers differ from

65
person to person, from time to time and from circumstances to circumstances. This
has been better explained in the following Figure 2.1.

Table 2.1: Investment Questions and Possible Answers of Well Informed and
Intelligent Investor
S. No. Question Possible Answers

a. Why should I invest? (i) to earn returns on idle resources,

(ii) to achieve specified capital in life, and
(iii) to make provision for an uncertain future.
b. What are my investment (i) Better return on investments,
objectives? (ii) Education of kids,
(iii) Building a house,
(iv) Provisions for retirement,
(v) Provisions for ill health, etc.
c. What are my investment (i) Equity Shares,
options? (ii) Preference Shares
(iii) Bonds and Debentures
(iv) Insurance schemes
(v) Mutual Fund Schemes
(vi) Derivatives, Futures & Options
(vii) Currency Futures
(viii) Gold Traded Funds
(ix) Exchange Traded Funds
(x) Commodity Derivatives, etc.
(xi) ADRs, GDRs, FCCBs, IDRs etc.
d. When should I invest? (i) After studying about the stock, company, its
products, and management.
(ii) After analyzing economic conditions.
(iii) After checking ex- cum dividend, ex-cum bonus,
other rights, etc. on the stocks.
(iv) After analyzing overall market conditions etc.
e. What care should I take (i) Obtain written documents regarding investment
while investing? (ii) Read and understand such documents
(iii) Find out the cost & benefits associated with these
(iv) Assess risk-return profile of the investment
(v) Know liquidity and safety aspect of the investment
(vi) Seek clarifications about the investment and the
intermediary
(vii) Deal only through a SEBI registered intermediary
(viii) Explore alternate options in case something wrong
goes with the investment, etc.
f. What should I do if I (i) To lodge a complaint with the entity concerned at
have any grievances? the first instance.
(ii) To contact stock exchange grievance cell.
(iii) To lodge on-line complaint to SEBI.

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Figure 2.1: Investment Cycle of a Well-informed and Educated Investor

What care
should I take
while
investing?

What should
be my Why should I
investment invest?
objective?
Investment
Decision-
making
Process

What are my
When should I
investment
invest?
options?

What if I have
a grievance?

However, the ultimate objective is to have maximized returns on his investments.

Gettess (2012) is of the view that if the investors can lose money fast in the markets,
they can earn it fast too. The investors are advised to study and answer to all possible
questions before venturing out. Investors should enter into those markets that are
more liquid. He further advised the investors not to expect unrealistic expectations.

2.2.3 Ill-informed Investment Cycle

An ill-informed investor makes his investment decisions based upon tips, rumors,
greed, borrowed money, expectations of quick gains and tips received from others.

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 Table 2.2: Possible Causes and Reasons for Investment Cycle of an Ill-
informed Investor

S. No. Investment Possible Answers

Question
a. What happens An ill-informed investor always seeks tips from the so
if investor called market experts and other market players, and
based his based upon the tips, he invests his hard earned money,
decision on and thereafter loses his investments.
TIPS?
b. What are the An ill-informed investor invests his hard earned money
consequences based upon the rumours and grape-wines. Many
of unscrupulous elements spread rumours about a
RUMOURS? particular stock with ulterior motive to make money, and
the innocent investor gets trapped and thereafter loses
his investments.
c. What is the Fear is one such of emotion that causes loss to the
after effect of innocent and ill-informed investor. Fear of losing money
FEAR on in stock markets makes an investor uncomfortable about
investor? his holding, and because of this, he takes ill-timed
decisions causing losses to him.
d. What happens Investment made by the borrowed money is bound to
if investor cause losses because investor has to pay the interest cost
trades on and there would always be pressure upon him to return
BORROWE the money, thus making ill-timed decisions.
D money?
e. What causes Stock markets give handsome returns as compared to
expectation of other class of assets, but not quick gains, as expected by
QUICK? most of the investors. Expectations of quick gains induce
the investor to make wrong decisions causing loss to
him.
f. What Greed is, on the other end, spectrum of fear. Greed of
GREED making quick money often burns fingers of the ill-
brings to informed investor. The investor forgets to sell an
Investor? overpriced share in the hope of making more money and
greed takes over, and when prices fall, he is left high and
dry.

An ill-informed investor does not study before making any investment decision;
rather he invests based upon the parameters as given in Table 2.2. All these factors
enumerated in the table account for the losses to the ill-informed investor and at the
end he blames everybody else except himself.

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The investment decision of an ill-informed investor can be best explained with the
help of the following figure:

Figure 2.2 : Investment Cycle of an Ill-informed Decision

Borrowed
Money

Rumours
Tips

Investment
decision-
making

Fear and
Panic Quick gains

Hope and
Greed

2.3 Retail Investors and Importance of Household Savings

2.3.1 Number of Retail Investors

Now coming on to number of investors, it can be said that the Indian stock market is
expanding in scope, size and scale day-by-day and so is the number of investors. As
of now, India has the highest number of listed companies in the world and has taken
over US, but the number of investors is not at all commensurate with the size of
population and the market depth. The participation by the retail investors in equity

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market is very low, and immediate corrective measures are required to be taken. The
number of investors in the present market place can very well be gauged from the
number of Demat accounts with both the depositories, NSDL and CDSL (Most of
these account holders have account in both the DPs). However, as per latest estimates,
the investor population with demat accounts is around 205 lakh which is enumerated
in Table 2.3.

Table 2.3: Number of Investors in Indian Depositories as on Oct. 2012

S. No. Depositories Number of demat

Accounts
1. NSDL 1,24,55,213

2. CDSL 81,05,353

TOTAL 2,05,60,566

Source: www.nsdl.co.in & www.cdslindia.com,

Last accessed on Nov. 10, 2012

2.3.2 Importance of Household Savings

There has been a tremendous growth in the rate of household savings in India which
at present stands at 33.8% of GDP. It has the highest gross domestic savings rate in
the world next only to China and Malaysia, much ahead of world rate of 18.9%.

But, unfortunately, these household savings are not channelized into the securities
market. Only 2% of the gross domestic savings in India are channelized in Indian
securities market through the participation of retail investors, while remaining 98%
goes into other different channels like fixed deposits, post office savings schemes,
insurance schemes, etc. which do not contribute to the faster growth of the economy
(Pathak, 2010). India accounts for just 0.7% of retail investors participating in
markets, whereas in America this figure is 36%, in Malaysia 39.2% of retail investors
trade in stock markets, in Hong Kong it is 21%, while our bordering country China
accounts for 10.5% people who own the stocks (Puri, 2010).

Table 2.4 provides the details of savings from 1990 onwards (RBI Monthly
Bulletin,2012).

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 Table 2.4: Gross Domestic Savings Rate- International Comparison
% of G.D.P.
Country 1990 1995 2000 2005 2007 2008 2009
India 22.8 24.4 23.7 33.5 36.9 32.0 33.8
China 39.1 43.5 37.5 47.6 50.5 51.8 52.1
Indonesia 32.3 30.6 32.8 29.2 29.0 28.9 33.8
Malaysia 34.5 39.7 46.1 42.8 42.1 42.3 36.0
Pakistan 11.1 15.8 16.0 15.2 15.4 20.8 11.4
Sri Lanka 14.3 15.3 17,4 17.9 17.6 13.9 18.0
Thailand 33.8 35.4 31.5 30.3 34.8 31.5 32.4
Brazil 21.4 16.5 16.5 19.8 19.8 20.9 16.5
Mexico 22.0 22.6 21.9 22.3 24.2 24.9 20.9
France 21.2 19.7 21.4 19.5 20.3 19.8 17.0
Germany 23.1 22.7 22.1 22.2 25.4 24.9 21.4
Japan 33.7 29.7 26.9 25.0 25.4 23.8 20.7
US 16.3 16.9 16.7 14.1 14.0 12.5 11.4
World 23.2 22.6 22.2 21.7 22.5 21.4 18.9
Source: Reserve Bank of India, Monthly Bulletin, June, 12 (Quoted from
“World Development Indicators, 2011, World Bank)

In India, today, more than 75% business is with banks, 20% with insurance and less
than 5% with the capital market. We have US $ 400 billion of savings, which is
enough to meet our investment needs. Need of the hour is to encourage the savings to
channelize into the capital markets. This can be brought up by reducing the cost of
intermediaries, which is around 4.5% as against the global cost of just 1.75%.

Household savings constitute an important element in the overall savings in a country.

A retail investor only parks his capital out of this household savings. Government of
India has been mobilizing household savings of ordinary citizens through various
schemes launched by it and its various agencies. These savings ultimately get
deployed into profitable enterprises through issue of securities by various issuers.
Investors have always kept the parameter of safety in mind while investing their hard
earned capital in avenues. As per the study undertaken by SEBI and NCAER, (2000),
Fixed Deposits are still the most favourite, safe instruments for investment followed

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by Gold, US-64 (UTI), UTI other schemes, and equity shares rate poorly in this
context. Table no. 2.5 gives a detailed composition of savings of households in
various financial assets.

Table 2.5: Savings of Household Sector in Financial Assets (In per cent)
Year 99- 00- 01- 02- 03- 04-05 05- 06- 07- 08- 09- 10-
00 01 02 03 04 06 07 08 09 10 11
Financial
Assets
Currency 8.6 6.4 9.5 8.5 11.2 8.5 8.7 10.2 11.4 12.7 9.8 13.3

Fixed Income 84.2 89.4 82.4 85.6 81.6 85.4 83.9 80.6 78.2 87.3 85.0 86.7
investments
Deposits 39.2 44.3 37.9 41.5 38.8 37.0 47.4 49.1 52.2 60.7 47.2 47.3

Insurance/ 34.0 33.5 33.4 29.8 27.3 28.9 24.2 28.8 27.9 30.4 33.5 32.9
Provident &
Pension Funds
Small Savings 11.0 11.6 11.1 14.3 15.5 19.5 12.3 2.7 1.9 -3.8 4.3 6.5

Securities 7.3 4.3 8.0 5.9 7.5 6.0 7.2 6.9 10.1 -0.7 4.6 -0.4
Market
Mutual Funds 4.9 1.3 1.7 1.3 1.2 0.4 3.6 5.2 7.7 -1.4 3.3 -1.8

Government 0.9 1.6 5.7 4.3 7.5 4.9 2.4 0.3 -2.1 0 0.6 0
Securities
Other 1.5 1.4 0.6 0.3 -1.2 0.7 1.2 3.7 4.5 1.1 1.3 1.4
Securities
Total 100 100 100 100 100 100 100 100 100 100 100

Source: RBI, Annual Report, Various Issues

2.3.3 Shrinking Investors’ Population

Efforts made by the market intermediaries to increase the population of retail

investors have not met with the desired results. With the Indian population of more
than 120 crore, less than only 20 crore investors are holding financial assets. Among
those 20 crore investors, less than 2 crore investors participate in debt and equity
markets. This means that retail investors are shying away from the capital market
despite a very long six-year bull run. During this bull run, trading volumes increased
as much as 500%, the stock indices zoomed up around 600%, (the Sensex shot up
from around 3,000 to 21,000) and the various other stocks of good companies
consistently gave more than 25% annual return in terms of dividend and stock
appreciation (SEBI-NCAER Investor Survey, 2000).

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In a large populated country of more than 1200 millions, only 240 million have bank
accounts, just 100 million insurance cover and mere 20 million demat holders. If India
needs consistent growth we need to have larger participation of retail investors.
Efforts should be made to increase the number of bank account holders to 500 million
and demat account holders to at least 25 million by next five years time. We are a
country with the highest saving rates, but are not able to channelize it to the capital
markets as a means of investments. The lure of quick gains in secondary markets is
driving the retail investors away from the primary markets (Bhatnagar, 2010).

The Swarup Committee report found that the retail investor population has shrunk to
less than half since 2000-01. More worrisome is that the retail investor population has
been shrinking continuously since 1991-92, when Dr. Manmohan Singh, as Finance
Minister, kicked off India’s liberalization process, and SEBI was set up. The balance
has tilted in favour of bigger players, as more and more complex products have been
introduced and the stock markets have become more and more institutionalized. In
2003, SEBI and the National Council of Applied Economic Research (NCAER)
estimated that 21 million individuals had invested in equity or debentures while 19
million had invested in mutual funds. The reference period for that study was 2000-
01.

Although, the Government took number of measures to increase the participation of

retail investors, but results have not been encouraging. Amendments in erstwhile
SEBI (DIP) Guidelines paved the way for increased participation of retail investors as
reservation for retail investors has been increased from 25% to 35% in 100% book-
built issue. Moreover, SEBI has also made minimum 25% public shareholding in
listed companies mandatory through amendments in SEBI (DIP) Guidelines to boost
up the retail participation, as various PSUs and other corporate houses are expected to
disinvest to the tune of 1,25,000 crore to the public in next five years. But, despite
these measures, the participation of Retail Investors has not increased at all.

2.4 Scams and Retail Investors

World over securities markets have been marred by scams, manipulations, distortions,
etc. “I can calculate the movement of the stars, but not the madness of men” (Faber,

73
2011). The said quote is attributed to Sir Isaac Newton who lost in the South Sea
Stock crash during the period December 1718 to December 1721. Indian securities
market has witnessed a number of scams due to the loopholes in the system, and
because of these loopholes unscrupulous persons take undue advantage at the cost of
majority of investors. But the tragedy is that it is always the retail investors that are
most adversely affected. Patil (2010) is of the view that each global crisis has its own
initial triggering causes but have the similar underlying problems of economic greed
and reckless risks by the market players.

If we count the number of scams, these will outnumber the count on the fingers, but
the painful memories of Harshad Mehta Scam in 1992, Ketan Parekh Scam in 2001
and UTI fiasco in 1999-00, plantation companies scams, demat scam and the latest
being the Satyam case are still fresh in our minds, and has eroded the confidence of
retail investors in securities market. That is why even today more and more people
rely on safer mode of investment like FDR, Bank Savings, NSC, etc. and
consequently the stock markets’ participation is very low. Bernanke (2009) was of
the view that the challenge faced by regulators is to strike the right balance to strive
for the highest standards of consumer protection without eliminating the beneficial
effects of the responsible innovations on consumer choice and access to credit.

Venugopal (2012) righty states that investors face some more grievances other than
listed by SEBI. These are mainly due to lack of market liquidity in many securities,
excessive speculation in the market, price rigging on many scrips, insider trading by
those possessing price sensitive information, excessive premium charged by some
company promoters under the guise of free pricing norms etc.

The reforms introduced in the year 1990 and afterwards have resulted in sound and
vibrant Indian Stock Market, but at the same time these have also brought many ills
with them. A critical look at the happenings in the past painfully reveals the agony
of small investors during the post liberalization era. They have always been at the
receiving end subject to unjustifiable losses and mental torture because of the
systemic failures and the scams that have occurred in the capital markets in one form
or other. The various stock market intermediaries, Market Regulator and other
regulatory organizations have realized the importance of the stakeholders,
74
shareholders or investors but a lot still, is required to be done. Table no. 2.6 depicts
the top ten scams that have hit the Indian Securities Market and the quantum of the
amount involved in each of these scams.

Table 2.6: Top Ten Scams in Indian Securities Market

( in mn.)
S. No. Name Year Estimated
Amount
1. Harshad Mehta 1992 45000
2. C.R. Bhansali 1994 12000
3. Cobbler Scam 1995 10000
4. UTI Scam 2000 320
5. Ketan Parekh 2000 10000
6. Dinesh Dalmia (DSQ Software) 2001 6350
7. Sanjay Aggarwal (Home Trade) 2001 6000
8. Uday Goyal (Plantation Scam) 2003 2100
9. IPO Scam 2005 2338
10. Satyam Scam 2009 80000
Source: Siddarth Singh, Top 10 Scams in India, www. indianblogger.com

2.5 Measures Initiated To Protection Retail Investors

2.5.1 Introduction

Protecting the interests of the investors needs to be the top priority of the market
regulator and various market intermediaries. A well-protected investor feels safe and
secure and puts his hard earned money in securities market. In case the investor does
not feel safe, he will not put his money; and the economy would be deprived of the
much-needed finance. It is good to note that the market regulator has realized this
importance and has put in place a system to ensure availability of adequate, up-to-date
and correct information to the investors so as to enable them to take timely and well-
informed investment decisions. Corporate Governance is also gaining significance,
more particularly in the wake of globalization and privatization. The regulator in
order to ensure the protection of Retail Investors has initiated a number of measures.
The various stock market intermediaries, market regulator and other agencies have
taken up the task of protecting this vital segment of the capital market, i.e., retail
investor but a lot still required to be done.

75
There is increased evidence to suggest that the investor protection is the need of the
hour, if India expects consistent double-digit growth. Integrity of the financial
markets and the well being of the economic power depends upon the accountability of
the corporate houses and the level of the investors’ confidence in various instruments
of financial markets. There is a growing concern at the global level to make the
capital market safer, transparent, deeper and vibrant, so as to ensure un-interpreted
flow of the funds to the economic mainstream.

2.5.2 Measures for Protecting the Interests of Retail Investors

SEBI in its various Annual Reports has prescribed the initiation of number of steps
for investor protection in Indian securities market which are detailed as follows:

2.5.2.1 Enactment of SEBI (DIP) Guidelines

SEBI had issued a number of DIP (Disclosure & Investor Protection) guidelines in the
interest of investors. These guidelines cover the following:

1. Eligibility for issuer Companies,

2. Cast responsibility on Market Intermediaries, and
3. Observe high standards of integrity and fair dealings.

These guidelines have been replaced with SEBI (ICDR) Regulations, 2009.

2.5.2.2 Introduction of Screen Based Trading

NSE introduced screen Based Trading System in India in 1996 by out placing of open
outcry system. This has been a landmark development in Capital Market of India,
which brought transparency, speed and efficiency in the trading system. At present
100% trading is done through Screen Based Trading System (SBTS). Online real time
trading through SBTS is fully automated. It has broken the barrier of distance. A
person sitting far away has access to same trading screen as available in the Stock
Exchange premises.

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2.5.2.3 Reduction in Trading Cycle

Initially trading cycle was from 14-30 days and trades used to take 21-45 days to
settle. Later on, SEBI introduced weekly settlement in Indian Market. To further
shorten the settlement cycle in order to protect the interest of the investors, trading
cycle was further reduced to T+5. Today, T+2 system is working efficiently and
SEBI further aims to bring down to T+1 system in the Indian Market. There is talk for
further reduction of trading cycle in regulator’s mind to T+1 and vision towards T+0.

2.5.2.4 Dematerialization

After dematerialization, the role of company with regard to transfer of shares has been
reduced to nil as shares are electronically transferred through depositories and it’s
various participants.

1. It has eliminated tribulations associated with physical shares.

2. No delays in transfers and shares are freely transferable.
3. It does not attract stamp duty (Indian Depository Act).

2.5.2.5 Introduction of Derivatives

Derivatives have been introduced in index and individual stocks in a phased manner.
It assists market participants to manage the investments better through the mechanism
of hedging, arbitrage and risk mitigation. Two derivative instruments, i.e., futures &
options have been introduced in Indian Markets, which are showing huge trading
interest from all categories of investors.

2.5.2.6 Introductions of Risk Management Measures

(i) Capital Adequacy Requirements for Brokers and Sub-brokers

Brokers and sub-brokers under capital adequacy requirements stipulated by SEBI are
required to have adequate paid-up capital at all times to be eligible for trading.
Further, they are required to deposit Base Minimum Capital with the Exchanges,
which varies from Exchange to Exchange.

77
(ii) Adequate Margin Requirements even at Client Level
SEBI has put in place margining system on the basis of Value at Risk (VaR). These
margins are calculated on the basis of risk exposure of particular group of shares.
These requirements keep on changing with the developments taking place in the
market.

(iii) Limits on Exposure and Turnover

In order to protect the interests of the investors and to make brokers to honour their
obligations, SEBI has put in place exposure and turnover limits through online
position monitoring of brokers and sub-brokers. This ensures safety and efficiency of
the market. If any broker, sub-broker crosses his exposure limit, the robust trading
system software automatically disables his trading terminal. The brokers and the sub-
brokers can set the similar limits for their clients as well. (SEBI Master Circular No
CIR/ MRD/ DP/ 42/ 2010).

2.5.2.7 Investor Education

SEBI has initiated massive public advertisement campaign for educating investors
through print and electronic media. A large number of Investor Awareness
Workshops have been organized to disseminate investor awareness, strengthening of
investor redressal mechanism etc. by SEBI and various market intermediaries.
Ministry of Finance too have initiated the move for investor education and roped in
various statutory and non-statutory bodies in order to spread mass investor awareness
at various town and other smaller places.

2.5.2.8 Setting up of Clearing Corporation/ Clearing House

The leading Exchanges NSE & BSE have set up their respective Clearing
Corporations in order to carry out the functions of clearing of trades efficiently.
Settlement risk has been reduced to a considerable extent due to the establishment of
clearing corporations, which have adopted latest technologies and professional
approach.

78
2.5.2.9 Professional Management and Demutualization of Stock Exchange

This path breaking reform has been introduced in the stock exchange recently. The
stock exchanges, which were earlier owned managed and controlled by the brokers,
are now, being managed by professionals. Moreover, the representation of broker
members on the governing board has been reduced to one-fourth of the total strength
of the governing board. Their participation will be further reduced to nil in a phased
manner. The known “Not for Profit” character of the Exchanges have also changed to
the “for profit” character.

2.5.2.10 Regulations to the Protect Investor’ Interest against Takeover, Insider Trading
or Fraudulent Practices etc.

SEBI has framed various regulations pertaining to substantial acquisitions of shares

and takeovers, insider trading and fraudulent practices. Through these regulations,
SEBI is empowered to impose a maximum penalty of Rupees 25 crore for violation of
its regulations.

2.5.2.11 High Level of Corporate Governance

SEBI since its inception has been endeavouring to introduce highest level of corporate
governance practices in India through suitable provisions in the listing agreement.
Corporate governance essentially means maximization of stakeholders’ interests,
which includes shareholders, society at large. SEBI through recent amendment in
clause 49 of the Listing Agreement has comprehensively defined framework for
corporate governance for listed companies, which has been implemented w.e.f. 31st
December, 2005 (Listing Agreement pursuant to SC(R)A, 1956).

2.5.2.12 Testing and Certification in Securities Market

In order to create skilled professionals in the Securities market, SEBI introduced

testing and certification of market intermediaries. Any market intermediary (Broker,
Sub-broker, and Mutual Fund Agent) who does not hold certification in financial
market is not allowed to operate in market as such. This is a good international
practice, which has been suitably adopted in India. This puts the discipline in the
whole markets.

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2.5.2.13 Margin Trading for Improving Liquidity

To improve liquidity in the market, SEBI has initiated steps to introduce margin
trading. Trading in the securities market is done with borrowed resources-funds or
securities. The margin trading provides facility to trade in the market with margin
capital and this helps in increasing the liquidity in the markets. Whenever there is an
insufficient flow of demand and supply forces due to lack of funds or securities, the
margin trading enables investors increase their purchasing / selling power and raises
the possibility of increasing their profits.

2.5.2.14 Securities Lending and Borrowing Mechanism (SLBM)

Securities lending and borrowing mechanism provides liquidity and price discovery
by offering equal opportunities of short selling and margin trading to both buyers and
sellers. This further ensures non-failure of delivery and reduction of unsystematic
risk. Issues regarding settlement risks are addressed through borrowing and lending
securities by clearing corporations. Clearing corporations can borrow securities on
behalf of members for the purpose of meeting their pay-on obligation, subject to some
conditions. This practice was stopped for a while by SEBI, but has now been
restarted.

2.5.2.15 National Institute of Securities Market

National Institute of Securities Market (NISM) is a public trust, established by the

Securities and Exchange Board of India (SEBI). Based in Navi Mumbai, NISM in its
ojectives, endeavours to enhance market quality through educational initiatives. It is
an autonomous body governed by its Board of Governors. An international Advisory
Council provides strategic guidance to NISM.

2.5.2.16 Establishment of Office of Ombudsman

SEBI has replicated this concept of Ombudsman in Indian Securities Market, which is
also prevalent in Indian Insurance and Banking Industry. The regulation for capital
market Ombudsman has been notified by SEBI and it is in the process of
operationalising this agency for redressal of investor complaints. An Ombudsman is
an official body, appointed by the government or by Parliament, who is charged with
representing the interests of the public by investigating and addressing complaints

80
reported by individual citizens. The purpose of the office of Ombudsman is to
safeguard the rights of citizens by establishing a supervisory agency independent of
the executive.

2.6 Observations of Experts and Role of Regulatory Authorities for

Protection of Retail Investors

All experts and authorities are of the opinion that protection of interest of retail
investor is of paramount importance in the present scenario as this vital segment of
stock market has been ignored and is staying away from the securities market. If the
retail investors are brought back, it will result into development of capital market as a
whole, which will have a bearing for better economic growth.

India has a target of achieving double-digit GDP growth in the future, and if large
number of retail investors join the capital market, it would mean that more capital is
being employed for productive purposes in the economy and India can achieve its
well-cherished dream of becoming a global economy by 2020.

Bajpai (2005), former Chairman of SEBI, is of the opinion that with the liberalization
and opening up of different sectors including capital market, the domestic investors
have a choice either to invest in India or outside. Many reforms have been undertaken
which include review of entry norms for IPOs, enhancing quality of issues, up-
gradation disclosure standards, review of risk management processes, re-orientation
of codes of conduct for all intermediaries and most importantly being the introduction
of corporate governance norms. All these measures were aimed at improving the
quality of the market and making India stand among the best-regulated markets in the
world.

Murthi (2005), former Chairman of Infosys, is of the view that all our institutions are
as good as our people. As long as you have crooks in the system, you will come
across problems because these crooks are able to by-pass regulatory mechanism you
put in place. He was of the opinion that it is also very important for us to educate our
people to become better quality citizens, and not to allow these crooks to benefit
taking advantage of innocent and ignorant people.

81
Narayan (2005), President, Tamil Nadu Investor Association says that small investors
depend upon rumours and tips even now, and they really don’t go behind the
fundamentals as he/she is not keen to spend any time to get proper advice. So when
his investment decision goes wrong and he blames everybody except himself. Here is
a need to educate these small investors to make prudent decisions. He, further goes on
to say that to make capital market healthy, we need to educate the investors. We need
to have investor awareness programmes and we must have a mechanism of investor
protection. We need to make the small investors a smart investor.

According to Dalal (2010), famous Finance Journalist, Capital Market should be

offered early to the students after they finish their matriculation examination. She
further says that she has been receiving lots of emails from many people wherein they
say that they want to understand the basics of capital market and there are hardly any
books on capital market. She advises that BSE should start courses of three months
duration in capital market, and goes on to further add that the single most important
corrective measure is to make market little safer. Education, bringing more people on
board, making the system more accessible, spreading on infrastructure would go a
long way in making market safer. At the same time, we don’t have to get complacent
because of having a world class system as most of the turnover figures in our market
are due to foreigners putting in their capital and trading in few scrips or when you
have 6000-7000 scrips where there is no trading.

Parekh (2005), Chairman, HDFC, was of the view that key to greater participation of
retail investor is the investor education. Investors who understand the risk and return
possibilities, will be able to make a more informed decision regarding their assets, and
would be prone to a lesser chance of disappointment from the capital markets.
Understanding that one type of investment or a particular asset allocation may not be
appropriate for all investors, and that each investor based on his objective and risk
appetite needs to allocate his savings into specified securities, is important.

Highlighting the role of investor education and protection, Jain (2005), Finance
Journalist, New Delhi says that media’s role is to highlight the grievance , but in a
manner in which it remains in focus. So, if you are doing an investor grievance
column, one way is to publish the grievance for a month or so and later follow this up
82
with action taken on the grievance. That is the only way the authorities will feel under
pressure to take action. The media is the vehicle that has exposed scams like Harshad
Mehta Scam, Ketan Parekh Scam etc. What restricts the media from doing better
work is the lack of access to the information on the entry cases of the scam and that
has to do with the fact that our investigating agencies do not do a good job.

While discussing the safe investing in stocks, Rambhia (2012), finds that investors
should trade in low volatility stocks as these stocks give absolute higher returns over a
longer period of time than the high volatility stocks.

83
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