Market regulator, Securities & Exchange Board of India (Sebi) Chairman, Chandu Bhave, is thinking about whether he should ban short selling in India or not.

Until now, Bhave has only issued warnings to foreign institutional investors (FIIs) to stop lending their shares, held in participatory notes or P-notes, overseas to those who short sell.

In the latest meeting on Wednesday, attended by 12 FIIs including names like Morgan, HSBC and Barclays Bhave told them to stop loaning out shares for short selling.

At a time when most developed markets have banned short selling in one form or the other, India seems to have become the favourite hunting ground for short sellers. Analysts indicate that if short sellers are allowed to hunt freely, the total hit India could take is about $5 billion.

What would really happen if the ban on short selling comes into effect?

The move may help on two counts. One is to reduce the excessive selling pressure on Indian stocks, thereby limiting the downside in the Indian markets. On the other hand, it will stop the outflow of dollars and help make the rupee get stronger.

While many fund houses in India feel that allowing short selling is only favouring the foreign investors who are able to make money in a falling market, some analysts also believe that banning of a market instrument may lead to the drying up of liquidity.

The big question therefore is, why isn’t SEBI going ahead with the ban if it has evidence indicating that short sellers didn’t mind pushing the markets down even when the Sensex fell below 10,000.