After two excellent years, FY2021 and FY2022, the performance of domestic broking industry moderated in Q1 FY2023 with a 10% quarter-on-quarter (QoQ) fall in net operating income (NOI) and 25% QoQ dip in net profit. According to an ICRA Research, geopolitical concerns and the adverse macroeconomic outlook have affected investor mood, resulting in a fall in profitability (profit after tax (excluding mark to market gains)/NOI) to 34% in Q1 FY2023 from 38% in Q4 FY2022, along with a decline in the transaction volumes of high-yielding cash broking segment (see exhibit 1). Due to market corrections, net fair value losses on the investment book of some companies also dragged down the overall profitability. Domestic capital markets had a great performance in the past two fiscal years, with healthy participation from retail investors and domestic institutions and a large number of initial public offerings. As average daily turnover (ADTO) more than quadrupled (see exhibit 2) in the preceding two fiscals to about Rs. 72 lakh crore in FY2022, the broking industry reported a record performance. NOI of ICRA's sample of broking companies nearly doubled during this time, and their profitability expanded from 25% in FY2020 to 38% in FY2022.
Giving more insight, Mr. Deep Inder Singh, Vice President, ICRA states, "As the incremental retail participation dampened in the current fiscal, the pace of new client additions slowed compared to the last fiscal. Also, notwithstanding the recent trend reversal, the Foreign institutional investors (FII) remained net sellers in H1 CY2022, which also weakened investor sentiment. Amid this, DIIs helped the market in FY2022. Given the ongoing monetary tightening domestically and globally, the sustained level of participation from FIIs and retail investors in the domestic markets remains a key monitorable."
The total number of demat accounts stood at 98 million as of July 2022, up from 55 million as of March 2021 and 41 million in March 2020 with average monthly additions of about 3 million in FY2022. Increasing retail participation in recent years has been a significant driver of revenue growth for broking companies. Retail clientele from tier 2 and 3 cities and younger demographics have also increased in the recent years. The pace of additions, however, slowed in Q1 FY2023 to about 2 million accounts per month.
Smaller brokers are losing active client market share to larger firms due to industry consolidation. Stricter compliance, technology requirements, and discounted pricing pressures have hurt small brokerages. Discount brokerage houses are estimated to have accounted for about 60% of NSE active clients as of June 2022, up from 2% in March 2016. Rapid growth in the last two years has been fuelled by the capital markets rally, the ease of the know your customer (KYC) process by enabling online KYC, and the use of technology apps.
The NOI of ICRA's sample rose to Rs 14,258 crore in FY2022 from Rs 10,604 crore in FY2021, a 34% YoY rise, though the companies saw a 10% QoQ decline in Q1 FY 2023 (see exhibit 3). Companies reported a significant increase in interest income from capital market exposures in FY2022 as a result of the equity market rally; however, this remained flat in Q1 FY2023. As equity markets corrected, companies reported a 12% QoQ fall in broking linked income in Q1 FY2023. The leverage levels of brokerage groups have increased in recent years due to capital market financing through loan against shares (LAS) and margin trade funding. Changes in regulations have also increased brokerage firms' operating capital requirements, which has impacted the leverage. Recent rising interest rates amid volatile market conditions could reduce investors' appetite for leverage and in-turn adversely impact the net interest income for brokers.
Adds Mr. Singh, "Nonetheless, overall retail participation and transaction volumes are expected to remain healthy compared to the pre-COVID-19 pandemic levels. On the back of this, the outlook for the brokerage industry is stable, though its revenue trajectory and profitability are expected to moderate from the FY2022 levels."