The Hindu Business Line : PDs have little to complain about

Ahead of the current proposal, the RBI should switch on the screen-based order trading system with a firm date provided in the April 28 Credit Policy. If the NSE can run the screen for equities, there is no reason why debt deals not be done on the screen.

GOING by the 10-page Discussion Note on the Primary Dealer System, the RBI will pull out of government paper auctions from April 1, 2006, dumping the job on 17 primary dealers. Primary dealers (PD) will solely exist to service the gilts market "in all interest rate cycles" and trim exposures to other markets. Some of the smaller PDs, who deem the job onerous, have been given the exit option of merging with their parent banks.

Primary dealers will be the focus of operations. "The primary objectives of the PD system are to support the government's borrowing programme and provide liquidity in the secondary market. It is, therefore, desirable that the activities of the PDs remain focused on these objectives. The measures suggested in this note will create an environment in which PDs would have the wherewithal to operate in all interest rate cycles. Therefore, PDs' exposures to non-government securities as well as off-balance sheet business, including merchant banking, should be restricted in terms of appropriate limits on the risk-weighted assets in non-government securities exposures. In addition to current eligibility norms of becoming a non-bank financial company (NBFC) and the requirement of predominance of operations in government securities, permitted structures for PD business may be expanded to include banks directly undertaking PD activity as a department with independent subsidiary books of account. In this background, appropriately restructuring the PD system may be encouraged, with smaller PDs either raising the capital base or merging with parent banks where there are bank subsidiaries, if they so desire."

Does it mean PDs cannot surrender their licences? PDs may not have winced at the RBI offer if it had come a year ago, when every market player (including banks) made money on a low interest regime egging prices (interest rates or yields are inversely related to prices). It came to such a pass that bank chairmen forgot lending to bank on treasury incomes; not surprisingly, for the year ended March 31, 2005, bankers are wearing sour faces. Bankers, PDs and the rest have a one-way mind; they came on TV blah-blah shows talking of booming treasury incomes a year ago, now they are all into retail. Do we at all need so many banks and bank chairmen to do the same thing?

PDs will be posting losses for the year ended March 31, 2005, and the current year may be unkind with interest rates expected to go up with none daring to think differently. It could well turn the other way and dealers then may enjoy an extra large at the bars on Friday evenings.

The RBI regime is not as tough as it is made to be: PDs have access to the call market, cash and securities account with the RBI, refinance facility and access to the Liquidity Adjustment Facility. They are now being offered the exclusive privilege to operate in the primary gilt auctions. "Exclusivity enhances the special character of PDs as the interface between the RBI and the markets. Exclusivity to PDs would not be an impediment to other categories of bidders since the only change for them is that they route their bids through PDs as is the informal system operating currently in the case of most banks. The proposed system would improve the transparency of the bidding process. Moreover, PDs with underwriting obligation would compete for client bids and, therefore, the access to the auction for non-PDs would be efficient. Non-competitive bids can, however, be received directly from banks or PDs as at present. Retail competitive bids will be placed through PDs or with banks that would, in turn, place them through PDs," says the RBI Note.

Will banks sup with PDs if yields are high and prices low?

The central bank is also planning to switch over to book building for some issues of government securities. Select PDs will act as arrangers for an issue (three or four arrangers per issue). "Each PD would arrange to place the stock within a range mutually agreed between the RBI and the PD. As the PD undertakes to arrange the issue, the success of the issue is guaranteed, albeit at a cost. This method can also be used as an incentive for the PDs for better performance in primary and secondary markets," explains the Note.

Ahead of the current proposal, the RBI should switch on the screen-based order trading system with a firm date provided in the April 28 Credit Policy. Most market players carry illiquid scrips as the phone-market is at best keen on five to six papers, depending on the whims of six brokers. If the NSE can run the screen for equities, there is no reason why debt deals not be done on the screen.

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