Should stock broker firms charge compound interest on their lending to clients?

By R.M.B. Senanayake

Recently I discovered that a licensed stock broker firm which I dealt with was charging me compound interest – which is interest not only on the principal debt but also on any interest accrued. If the interest chargeable period or the grace period for repayment of the principal is reduced, then compound interest provides the lender with a large source of income which in the Middle Ages would have been called usury. 

Our Civil Procedure Code permits it where the two parties have agreed to it in writing.  Often the borrowers don’t read the fine print and I can’t imagine any borrower ever borrowing at all if compound interest is payable by him. It is different from a penal rate of interest for delayed payments. So in my experience nobody in trade ever borrows on compound interest, not even in the Pettah market where borrowing is on a ‘day’ basis. 

But stockbroker firms at least some of them, like the one I unfortunately had to deal with, because of a Stock Exchange Rule that prohibited employees of broker firms dealing with one’s own broker firm where one was employed, wanted it that way. No wonder the stock market is in the doldrums. Stock markets like all other markets, both spot and forward or future markets, are sustained by trading and not by those who are ultimate borrowers. So to discourage trading is not the promotion of markets. 

Many stock market investors may like me unfortunately not study the fine print in the Credit Agreements. The penal clause provides for compound interest to be charged which is interest not only on the principal debt but the debt plus interest in arrears which keeps on increasing.  I did not realise that the broker firm I dealt with had a clause permitting the charging of compound interest in the case of delayed payment in addition to the penal rate of interest which is higher than the rate provided for. 

Unfortunately there is no formal signing of the Credit Agreement where the borrower is given a copy of the signed Agreement. So I was not given a copy of the Credit Agreement signed. There were also no formal witnesses to the agreement when I signed the Agreement with the Broker firm. I was also not given a copy of the Agreement as is usual with formal Agreements. 

It is no wonder that our stock market is in the doldrums. Markets whether stock markets or commodity markets are sustained by trading of intermediaries and not by the trades of ultimate buyers and ultimate sellers. Unfortunately in our country such intermediaries are looked upon as unnecessary middlemen. But that is the nature of modern markets although some people think such intermediaries who are traders and not ultimate buyers or sellers should not be allowed. 

In my trading experience both in commodities and stocks I have not come across such a condition where compound interest is charged, while a penal rate of interest is also charged on the principal debt. I think members of the public who are investors should be aware of this condition. Of course it is not economic to trade in the stock market or any other commodity market if the cost of credit is compound interest. I am not aware of any other trade in the country where compound interest is charged in this manner. 

It is of course legal if the two parties – the borrower and the lender agree to it specifically. So stock market players must beware since no trade is possible with payment of compound interest. No wonder the stock market is in the doldrums. Regulators should realise that there must be a market first to regulate. What promotes trading is the rate of interest and the prospect of making money through intermediation. Compound interest will not permit trading and without active trading no market is sustainable, let alone develop. So those who want to promote the market should look towards the regulators. 

Anyway if compound interest is charged, no borrowing will take place at all; not in the stock market nor perhaps in any market. It is not economic to do so. 

I am writing this for the benefit of the members of the public who may seek to trade on the stock market borrowings from broker firms.