Tag: Osmania University B.com Notes

Government securities market in India is narrow and unlike other countries inactive. The general investors do not buy these securities. The Reserve Bank of India and financial institutions are the main investors of government securities.

The government securities market in India supports the capital market and has no negative effect on it. The funds that it collects are mainly for minimizing the cost of servicing and for the planned priorities of the economy.

Government securities have been employed by the Reserve Bank of India in such a way that it is able to maintain some clear pattern of yield and a proper maturity distribution policy. It has also been considered safe by Reserve Bank to purchase securities before maturity in order to maintain stability.

The Reserve Bank of India has used open market operations to provide inexpensive finance for government and has tried to maintain funds with the view of achieving stability in the future.

The Reserve Bank of India has also used the techniques of maintaining the reserve ratio and the statutory liquid ratio and the technique of moral suasion. This it has done for controlling bank liquidity and for achieving the objectives of debt management.

Prices and Yields on Government Securities:

The prices of government securities remain stable, although the bank rate has been increasing. In India usually the bank rate influences the security prices inversely and in opposite direction.

But the Reserve Bank of India has tried to stabilize the prices of government securities. Thus, it has been able to do by refraining from making any change in the purchasing and selling rates of the different loans which are placed on its list.

It has also tried to manipulate the selling rate of Treasury Bills of government. The Reserve Bank of India has many a times mopped up the surplus funds by lowering the rate of sale of Treasury Bills. This is an indication that the Reserve Bank of India was concerned with the rate of term loans and wanted to continue with its stability.

The yields on securities can be studied if the investor holds the security continuously. An investor can then observe year to year changes in the coupon rate, running yield and redemption yield.

It is common practice in India that the government securities are sold far below the face value. This itself shows that the redemption yield is higher than the bond rate because the redemption yield is equal to the face value when the bond is purchased at the face value or par value.

In India, government securities have continuously increased the rate of return. Also, there has been no ceiling rate on government securities.

However, government securities show that even with the continuous increase in interest over the years, coupled with price stability, the rates given by government are far below than what the investor would hope to gain if he invested his funds in industrial securities. The government securities, therefore, are not an attractive form of investment.

In India, government securities have been an important or useful part of the monetary management and fiscal policy. The Reserve Bank of India has executed the interest rate of government selling, borrowing, purchasing and lending and has also influenced the prices and yields. It has also played an important role in maintaining a statutory liquidity ratio with the commercial banks in the country.

This has the effect of reducing or improving the liquidity position of the bank. As has been pointed earlier, government securities have not made a market for themselves. They have generally been issued for the reason of monetary, fiscal and debt management and for using the funds for the planned priorities of the country.

Government securities in India are invested by financial institutions and commercial banks. Although it comprises a larger segment than the industrial securities market in India, very little knowledge is presently available about its operation to the common man.

Dealer

A primary dealer is a firm that buys government securities directly from a government, with the intention of reselling them to others, thus acting as a market maker of government securities. The government may regulate the behaviour and number of its primary dealers and impose conditions of entry. Some governments sell their securities only to primary dealers; some sell them to others as well. Governments that use primary dealers include Australia, Belgium, Brazil, Canada, China, France, Hong Kong, India, Italy, Japan, Singapore, Spain, the United Kingdom, and the United States.

A Primary Dealer will be required to have a standing arrangement with RBI based on the execution of an undertaking and the authorisation letter issued by RBI covering inter-alia the following aspects:

(i) A Primary Dealer will have to commit to aggregative bid for Government of India dated securities on an annual basis of not less than a specified amount and auction Treasury Bills for specified percentage for each auction. The agreed minimum amount/ percentage of bids would be separately indicated for dated securities and Treasury Bills.

(ii) A Primary Dealer would be required to achieve a minimum success ratio of 40 per cent for dated securities and 40 per cent for Treasury Bills.

(iii) Underwriting of Dated Government Securities: Primary Dealers will be collectively offered to underwrite up to 100% of the notified amount in respect of all issues where the amounts are notified.

(iv) Treasury bill issues are not underwritten. Instead, Primary Dealers are required to commit to submit minimum bids at each auction. The commitment of Primary Dealer’s participation in treasury bills subscription works out as follows:

(a) Each Primary Dealer individually commits, at the beginning of the year, to submit minimum bids as a fixed percentage of the notified amount of treasury bills, in each auction.

(b) The minimum percentage of the bids for each Primary Dealer is determined by the Reserve Bank through negotiation with the Primary Dealer so that the entire issue of treasury bills is collectively apportioned among all Primary Dealers.

(c) The percentage of minimum bidding commitment determined by the Reserve Bank remains unchanged for the entire financial year or till furnishing of undertaking on bidding commitments for the next financial year, whichever is later. In determining the minimum bidding commitment, the Reserve Bank takes into account the offer made by the Primary Dealer, its net owned funds and its track record.

(v) A Primary Dealer shall offer firm two-way quotes either through the Negotiated Dealing System or over the counter telephone market or through a recognised Stock Exchange of India and deal in the secondary market for Government securities and take principal positions.

(vi) A Primary Dealer shall maintain the minimum capital standards at all points of time.

(vii) A Primary Dealer shall achieve a sizeable portfolio in government securities before the end of the first year of operations after authorisation.

(viii) The annual turnover of a Primary Dealer in a financial year shall not be less than 5 times of average month end stocks in government dated securities and 10 times of average month end stocks in Treasury Bills.

Of the total, turnover in respect of outright transactions shall not be less than 3 times in respect of government dated securities and 6 times in respect of Treasury Bills. The target should be achieved by the end of the first year of operations after authorisation by RBI.

(ix) A Primary Dealer shall maintain physical infrastructure in terms of office, computing equipment, communication facilities like Telex/Fax, Telephone, etc. and skilled manpower for efficient participation in primary issues, trading in the secondary market, and to advise and educate the investors.

(x) A Primary Dealer shall have an efficient internal control system for fair conduct of business and settlement of trades and maintenance of accounts.

(xi) A Primary Dealer will provide access to RBI to all records, books, information and documents as may be required,

(xii) A Primary Dealer shall subject itself to all prudential and regulatory guidelines issued by RBI.

(xiii) A Primary Dealer shall submit periodic returns as prescribed by RBI.

(xiii) A Primary Dealer’s investment in G-Secs and Treasury Bills on a daily basis should be at least equal to its net call borrowing plus net RBI borrowing plus net owned funds of Rs 50 crore.

STCI Finance Ltd (formerly Securities Trading Corporation of India Limited), is a Systemically Important Non-Deposit taking NBFC registered with Reserve Bank of India (RBI). Presently STCI Finance Ltd is classified as a loan NBFC.

In May 1994, STCI Finance Limited was promoted by RBI with the main objective of fostering an active secondary market in Government of India Securities and Public Sector bonds. RBI owned a majority stake of 50.18% in the paid-up share capital of the company. In 1996, the Company was accredited as the first Primary Dealer in the India. As one of the leading Primary Dealers in the country, the Company was a market maker in government securities, corporate bonds and money market instruments. Its other lines of activities included trading in interest rate swaps and trading in equity – cash & derivatives segment. The Company enjoyed a successful track record of achieving profits during consecutive years spanning nearly a decade. RBI divested its entire shareholding in STCI in two stages- first in 1997 to bring it down from 50.18% to 14.41% and the balance in 2002 to the existing shareholders. Bank of India became the largest shareholder in the company with 29.96% stake.

In order to diversify into new activities, the Company hived off its Primary Dealership business to its separate 100% subsidiary, STCI Primary Dealer Limited (STCI-PD) in June 2007. Since year 2007, the Company has been undertaking lending and investment activities with its main focus on lending/ financing activities. With growth in the size of the Look Book, the lending activity became the core business of the Company and STCI Finance Limited was classified as a Loan NBFC . With a view to reflecting the lending/ financing business of the Company, the name of the Company was changed from Securities Trading Corporation of India to ‘STCI Finance Limited’ with effect from October 24, 2011.

STCI Finance Limited is a diversified mid-market B2B NBFC offering its product and services across multiple locations in the areas of Capital Markets, Real Estate, Corporate Finance and Structured Finance.

Subsidiaries:

STCI Primary Dealer Limited (STCI PD)

This company is a wholly owned subsidiary of STCI Finance Limited established consequent to the hiving off of the Company’s primary dealership business in line with the Reserve Bank of India guidelines on diversification of business activities by primary dealers. The Company undertakes trading in government securities, corporate bonds, money market instruments, interest rate swaps and trading in equity.

STCI Commodities Limited

This company is a wholly owned subsidiary of STCI Finance Limited. The Company has discontinued its commodity broking operations with effect from September 20, 2011 and has also surrendered its membership with Multi Commodity Exchange (MCX) and National Commodity and Derivative Exchange (NCDEX).

Money market is the market for short-term loanable funds, as distinct from the capital mar­ket which deals in long-term funds.

Money mar­ket is also defined as a mechanism through which short-term funds are loaned and borrowed and through which a large part of the financial transac­tions of a particular country are cleared.

The money market is divided into direct, negotiated, or customers’ money market and the open or impersonal money market. In the former, banks and financial firms supply funds to local customers and also to larger centres such as London for direct lending. In the open money market, idle funds drawn from all-over the country are transferred through intermediaries to the New York City market or the London market.

These intermediaries comprise the Federal Reserve Banks in the USA or the Bank of England in England, commercial banks, insurance companies, business corporations, brokerage houses, finance companies, state and local government securities’ dealers. The money market is a dynamic market in which new money market instruments are evolved and traded and more participants are permitted to deal in the money market.

Use of Surplus Funds:

It provides and opportunity to banks and other institutions to use their surplus funds profitably for a short period. These institutions include not only commercial banks and other financial institutions but also large non-financial business corporations, states and local governments.

Provides Funds:

It provides short-term funds to the public and private institutions needing such financing for their working capital requirements. It is done by discounting trade bills through commercial banks, discount houses, brokers and acceptance houses. Thus the money market helps the development of commerce, industry and trade within and outside the country.

Helps Government:

The money market helps the government in borrowing short-term funds at low interest rates on the basis of treasury bills. On the other hand, if the government were to issue paper money or borrow from the central bank. It would lead to inflationary pressures in the economy.

No Need to Borrow from Banks:

The existence of a developed money market removes the necessity of borrowing by the commercial banks from the central bank. If the former find their reserves short of cash requirements they can call in some of their loans from the money market. The commercial banks prefer to recall their loans rather than borrow from the central banks at a higher rate of interests.

Helps in Financial Mobility:

By facilitating the transfer for funds from one sector to another, the money market helps in financial mobility. Mobility in the flow of funds is essential for the development of commerce and industry in an economy.

Helps in Monetary Policy:

A well-developed money market helps in the successful implementation of the monetary policies of the central bank. It is through the money market that the central banks is in a position to control the banking system and thereby influence commerce and industry.

Equilibrium between Demand and Supply of Funds:

The money market brings equilibrium between the demand and supply of loanable funds. This it does by allocating saving into investment channels. In this way, it also helps in rational allocation of resources.

Promotes Liquidity and Safety:

One of the important functions of the money market is that it promotes liquidity and safety of financial assets. It thus encourages savings and investments.

Economy in Use of Cash:

As the money market deals in near-money assets and not money proper, it helps in economising the use of cash. It thus provides a convenient and safe way of transferring funds from one place to another, thereby immensely helping commerce and industry.

The monetary policy takes care of promotional aspects such as:

(i) Monetary integration of the country,

(ii) Directing credit flow according to policy priorities,

(iii) Assisting in mobilisation of the savings of the community,

(iv) Promotion of capital formation and

(v) Maintain an appropriate structure of relative prices and demand containment.

A liquidity adjustment facility (LAF) is a tool used in monetary policy, mainly by the Reserve Bank of India (RBI), which enables banks to borrow money through repurchase agreements (reposals) or banks to lend to the RBI using reverse repo contracts.

This arrangement manages liquidity pressures and ensures basic financial-market stability. The Reserve Bank of India transacts repositories and reverse repos within its open market operations in India.

The Liquidity Adjustment Facility or LAF is the principal operating monetary policy tool that allows banks to borrow money through repurchase agreements. This means, in order to meet short-term cash needs, bank, borrow money against government approved securities with an agreement to repurchase the same at a predetermined rate and date.

The liquidity adjustment facility is used to aide banks in the emergency arising out of severe cash shortage or acute liquidity crisis. It is used for modulating the short-term liquidity and transmitting the interest rate into the market.

Basic of a Liquidity Adjustment Facility

Facilities for liquidity adjustment are used to help banks overcome any short-term cash shortages during periods of economic uncertainty or any other stress caused by circumstances beyond their control. Different banks use eligible securities as collateral through a repo agreement and utilize the funds to ease their short-term requirements, thus remaining constant.

The facilities are introduced on a daily basis as banks and other financial institutions make sure they have sufficient capital on the overnight market.

The transaction of liquidity adjustment facilities takes place at a set time of the day, through an auction. A company that wants to raise capital to accomplish a shortfall is engaged in repo agreements, while one with excess capital is doing the opposite executing a reverse repo agreement.

Liquidity Adjustment Facility and the Economy

The RBI may use the facility for adjusting liquidity to manage high levels of inflation. It does this by raising the repo rate, which increases the cost of debt servicing. This, in turn, reduces the supply of investment and money within the economy of India.

Alternatively, if the RBI tries to boost the economy after a period of slow economic growth, the repo rate can be lowered to encourage businesses to borrow, thus increasing the supply of money.

For instance, analysts predict RBI to cut the repo rate in April 2019 by 25 basis points due to weak economic activity, low inflation, and slower global growth. However, as growth accelerates and inflation picks up, analysts expect repo rates to resume rising by 2020.

Repo Rate

Repo or repurchase option allows the scheduled commercial banks to borrow funds from the Reserve Bank of India against any government approved securities with an agreement to repurchase them in the near future at a predefined rate of interest. The rate at which RBI charges from the banks against such lending is called the Repo rate. Through these operations, the liquidity is injected into the economy or the financial system.

Banking is the first sector to get affected by any change in monetary policies. A cut in repo rate can allow banks to borrow from the Reserve Bank of India at a cheaper rate and infuse higher liquidity in the banking system. This can lead banks to reduce their lending rates for customer leading to cheaper loans in the long term. As bank loans get cheaper, consumers can borrow and spend more which boosts consumption and can eventually lead to economic growth. However, this is depending on the decision by the bank whether to pass on the RBI repo rate cut benefits to their customers through cheaper loan offers.

Components

Preventing Economy “squeezes”: The Central bank increases or decreases the Repo rate depending on the inflation. Thus, it aims at controlling the economy by keeping inflation in the limit.

Hedging & Leveraging: RBI aims to hedge and leverage by buying securities and bonds from the banks and provide cash to them in return for the collateral deposited.

Short-Term Borrowing: RBI lends money for a short period of time, maximum being an overnight post which the banks buy back their securities deposited at a predetermined price.

Collaterals & Securities: RBI accepts collateral in the form of gold, bonds etc.

Cash Reserve (or) Liquidity: Banks borrow money from RBI to maintain liquidity or cash reserve as a precautionary measure.

Repo Rate Affect on Economy

Repo rate is a powerful arm of the Indian monetary policy that can regulate the country’s money supply, inflation levels, and liquidity. Additionally, the levels of repo have a direct impact on the cost of borrowing for banks. Higher the repo rate, higher will be the cost of borrowing for banks and vice-versa.

• Rise in inflation

During high levels of inflation, RBI makes strong attempts to bring down the flow of money in the economy. One way to do this is by increasing the repo rate. This makes borrowing a costly affair for businesses and industries, which in turn slows down investment and money supply in the market. As a result, it negatively impacts the growth of the economy, which helps in controlling inflation.

• Increasing Liquidity in the Market

On the other hand, when the RBI needs to pump funds into the system, it lowers the repo rate. Consequently, businesses and industries find it cheaper to borrow money for different investment purposes. It also increases the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.

Reverse Repo Rate

This is just opposite to the Repo rate, here the RBI borrows money from the commercial banks against government approved securities. The rate at which RBI pays interest to the commercial bank is called a reverse repo rate. Through reverse repo operations, the liquidity is absorbed from the economy or the financial system.

Whenever RBI decides to reduce the reverse repo rate, banks earn less on their excess money deposited with the Reserve Bank of India. This leads the banks to invest more money in more lucrative avenues such as money markets which increases the overall liquidity available in the economy. While this can also lead to lower interest rate on loans for the bank’s customers, the decision will depend on multiple factors including the bank’s internal liquidity situation and the availability of other potentially less risky and equally lucrative investment opportunities.

The Marginal Standing Facility (MSF) is the rate at which the scheduled commercial banks borrow funds fortnight from the Reserve Bank of India against the government approved securities.

Marginal standing facility (MSF) is a window for banks to borrow from the Reserve Bank of India in an emergency when inter-bank liquidity dries up completely. The Marginal standing facility is a scheme launched by RBI while reforming the monetary policy in 2011-12.

Marginal Standing Facility (MSF) is a provision made by the RBI through which scheduled commercial banks can obtain liquidity overnight, in the event that inter-bank liquidity completely dries up. This is a facility for emergencies, through which banks obtain liquidity support at the MSF rate, which is a rate higher than the repo rate.

Banks can avail immediate cash of up to a percentage, now 3%, of their NDTL under MSF, meaning that they can dip into their SLR to obtain liquidity support from the RBI at the MSF rate. It is a penal rate of interest at which the RBI offers banks funds under the Marginal standing facility. If a bank’s liquidity dries up due to, say, a loan-deposit mismatch, it could avail funds from the RBI at the marginal standing facility rate even if it does not have eligible securities beyond the SLR.

MSF is a short-term arrangement as banks generally do not run out of liquidity for a long time, but at a given point they may face a dire shortage of funds.

• Banks borrow from the RBI by pledging government securities at a rate greater than the repo rate under LAF (liquidity adjustment facility).
• The MSF rate is pegged 100 basis points or a percentage point above the repo rate.
• Under MSF, banks can borrow funds up to one percent of their net demand and time liabilities (NDTL).
• The minimum amount for which RBI receives application is Rs.1 Crore, and afterward in multiples of Rs.1 Crore.

Normally, banks pledge eligible securities above the SLR requirement to the RBI to obtain liquidity through loans at the repo rate. Now, if a bank exhausts this means, it can resort to the MSF provision to get quick money for a 1-day period by pledging, within the limits of SLR, government securities.

Objectives of MSF rate

The Marginal Standing Facility was introduced by the RBI in the 2011-2012 monetary policy and it helps both banks and the RBI in a handful of ways.

• There is less volatility in overnight lending rates thanks to MSF
• Banks have a way to plug short-term liquidity shortfalls with MSF
• With MSF, RBI has more control over the money supply in the economy

RBI uses Marginal standing facility to control and manage the money supply in the financial system. With the increase in the rate, the borrowing becomes expensive for the commercial banks and in return the loans become dearer for the individual or corporate borrowers, which will result in less flow of money in the market. Also, the MSF rate is often increased by RBI to curb the excessive availability of rupee and to avoid further rupee depreciation against a dollar.

Rate of Interest

The rate of interest on MSF is above 100 bps above the Repo Rate.  The banks can borrow up to 1 percent of their net demand and time liabilities (NDTL) from this facility. This means that Difference between Repo Rate and MSF is 200 Basis Points.  So, Repo rate will be in the middle, the Reverse Repo Rate will be 100 basis points below it, and the MSF rate 100 bps above it. Thus, if Repo Rate is X%, reverse repo rate is X-1% and MSF is X+1%.

Borrowing under MSF

• Banks can borrow through MSF on all working days except Saturdays, between 3:30pm and 4:30pm in Mumbai where RBI has its headquarters.
• The minimum amount which can be accessed through MSF is Rs. 1 crore and in multiples of Rs. 1 crore.
• The application for the facility can be submitted electronically also by the eligible scheduled commercial banks.