Unlocking liquidity through shortened settlement cycle: Empirical evidence from India

Abstract

Many jurisdictions across the world are considering shortening the settlement cycle in equity markets from T + 2 to T + 1 with the primary objective of promoting investor protection, reducing risk and improving efficiency. In addition to achieving these objectives, shortened settlement cycles also lower the funding liquidity demand with lower margin requirements, which could unlock liquidity in less liquid stocks. Using the data from Indian markets, which incrementally migrated securities from T + 2 to T + 1 each month, we construct a series of quasi-natural experiments and find that shorter settlement cycles improve market liquidity, and the improvement in liquidity is greater for stocks with smaller market capitalization. Shortening of settlement cycles can be a path to improving overall liquidity and widening its availability to illiquid stocks.