Despite the various benefits of the depository system, investor, particularly the retail investor is shy of demat trading. The following points explain the drawbacks of depository system in India.
1. Agency risk
The major issue which keeps the retail investor away from the depository system is the agency risk. From the view point of the investor, the risk perception in the depository system is no less than that in the present system of trading and settlement. It is true to say that in the present system, the agency risk is diversified among various players like brokers, registrar, postal system etc. In the depository system, though the depository participant is a reputed bank, the retail investor does not feel confident until effective insurance coverage is provided.
2. Lack of awareness
It is estimated that in India retail investors hold about 30% of the market capitalization. In spite of their considerable share in the capital market, they do not show adequate interest in demat trading. This is mainly due to lack of awareness among the retail investors or the fear of being caught in the tax net. Most of the investors are not aware of the benefits of demat trading.
3. Risk of loss in transit
Distribution of cash benefits accruing to investors can be expedited under depository system. But cash benefits cannot be disbursed electronically. Still they have to be sent by post. So, the risk of loss in transit is to be borne by the investor.
4. Multiplicity of charges
Under depository system, there are charges for opening of account, dematerialization, rematerialisation, etc. Apart from this, investors who intend to hold their investments in dematerialised form have to pay custody charges to the depository participant. All these charges may deter the retail investors from taking advantages of the system.
5. Reluctance for trading
Most of the existing shareholders do not opt for depository system. They intend to keep their securities only in physical form.
6. Fear of tax liability
A large number of transactions related to securities are not accounted for, because most of the buyers and sellers are not comfortable with their names appearing in computer print-outs as they fear being brought into tax net. This aspect prevents the investors from taking advantage of the depository system.
7. Inadequate infrastructure
In India, the infrastructure available for trading in demat shares is inadequate. The Depository Act and SEBI have overlooked the role of Clearing and Settlement Corporation.
For the successful operations of the depository, there should be a centralized clearing and settlement corporation handling the trade in all exchanges. The establishment of such a central institution will effectively facilitate smooth interaction with the various exchanges. Another problem is that the investors living in smaller towns will find it impossible to open a demat account.