Retailing Government Securities

When the budget is presented by the Finance Minister, newspapers report all important measures that touch the lives of ordinary citizens including how much money the Government proposes to borrow from the public in a financial year. But hardly anyone knows as to how the process of borrowing and lending works and where the money comes from. It is not surprising that the awareness about the Government bonds amongst the public is very poor considering that world over it is an institutional market where big players such as banks, pension funds, insurance companies, mutual funds, etc., buy in the primary market through auctions and trade in secondary market which is primarily an over-the-counter (OTC)market. 

The RBI working group report on enhancing liquidity in government securities devoted a chapter on ‘retail participation in G-sec market’ where it acknowledges the importance of diversification of categories of investors in G-Sec market and the factors inhibiting wider participation. However, it has not suggested solutionswhich break out of the existing framework in which the G-Sec market is organized. And the need of the hour is a solution in that direction.

Issues:

One major reason for poor retail participation is the lack of awareness as to the G-Sec. As the report pointed out, the existing infrastructure for G-Sec including the participants such as bank treasury departments, primary dealers (PD’s), etc. are concentrated only in Mumbai. Although the banks have a huge branch network, hardly any bank staff are aware of the G-Sec as a financial product to be sold to its customers. Moreover, there is no incentive for the banks to create awareness in these products. The other major ill is illiquidity. If retail investors are to be enticed with G-Sec’s, there must be adequate depth and continuous liquidity for G-Sec.

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The secondary market in G-Sec is conspicuous by its absence. The trading platforms of BSE and NSE for G-Sec’s with nationwide trading terminals have nil volume in most of the recent years owing to poor retail holding of G-Sec’s. Another area of concern is the complex procedures to transfer securities from SGL account to demat and vice versa. Even between depositories interoperability is not permitted a la securities market transactions as RBI is the Regulator, Custodian and Transfer Agent for Government securities.

Induced Awareness:

The first step in this direction for the Government/RBI is to issue tax free bonds which are hitherto issued by PSU’s such as REC, PFC, IIFL, HUDCO and NTPC as Government of India bonds and make them available for subscription through the branch network of the banks and pass on the proceeds to the concerned PSU which requires such funds.Onrecord, it will increase the liability of the Government of India to the extent that the bonds are issued. But at the same time, the liability does not stick to the Government as the principle and the interest will be serviced by respective PSU’s on whose behalf the proceeds are raised. In fact, many of the tax free PSU bonds get triple ‘A’ rating as they are financially sound with substantial ownership by the Government. As the banks do get commission for distributing these bonds, they will be glad to sell to their customers. In the year 2012-13 about Rs. 18,000 crores worth of bonds were raised of which 14,700 crores is through the public issue. In 2013-14, permission to issue tax free bonds worth Rs. 53,000 crores was received of which only Rs. 32,000 crores was raised till December, 2013. Therefore, every year in the Finance Act, the Government can make a provision for issuing tax free bonds on behalf of PSU’s. Care should be taken to ensure that the Government / RBI issuebonds as and when the PSU wants them to raise the finances without getting stuck in the maze of bureaucracy.

The existing role played by the PSU’s in managing the issue be allowed including decision making as to defraying expenses. As is the existing practice, the entire cost of the issue will be borne by the respective PSU. The only difference is that it will be called as Government of India Bond and it will be sold through banking branch network. This process will popularize G-Sec’s amongst the public at no additional cost to the Government.‘G-Sec’ as investment avenuewill also figure in the Investor Awareness Programmes being organized across the country by Exchanges and Depositories.

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Quid Pro Quo:

Another major drawback to be addressed in G-Sec market is the lack of liquidity. Although there are ninety plus G-Sec’s outstanding, the most active ones are top five securities which accounts for about 80-90% of the total G-Sec turnover. And the most active ones are the bonds with a tenure of ten years. Another characteristic of G-Sec market is that about 55% of the outstanding securities are held by the scheduled commercial banks. This is being held as a part of statutory liquidity ratio (SLR), which is currently 23% of demand and time liabilities of the scheduled commercial banks. As it is mandatory for the banks to invest in these securities, irrespective of the return on the securities, banks are forced to invest.While RBI shares the view that the SLR is required to be reduced over a period to free up bank resources for optimum utilization, it is better if a return-reward scheme is devised for availing lower SLR by the banks.In order to promote retail holding of G-Sec, RBI may permit banks to sell part of their SLR securities (say 5% of the total SLR securities held by a bank) to retail investors through their branch network with a clear understanding that they should buy back from the customers any time during the tenure of the securities. In order to undertake this activity the banks have to display in their branches bid and ask priceson a daily basis which are close to prices in G-Sec market in Mumbai, much the same way bank display the FD rates.This information can be spread through the core-banking network that is well in place in almost all banks. Whenever, investors need funds, they can liquidate in the branch and get cash immediately.The investor will also have a choice to sell it on the G-Sec trading platforms of exchanges once they get their visibility. With this policy framework in place, commercial banks which desire to free up their resources to earn higher return than what the G-Sec’s are offering will undertake marketing of G-Sec’s to its customers.

The scheduled commercial banks together hold Rs. 20, 000 billion G-Sec as at the end of March, 2013. If RBI permits even a 5% of the outstanding amount held by banks for offloading to retail investors, it will be Rs. 1000 billion. If the banks are able to earn even 1% higher return over the G-Sec return on this amount, it will be Rs. 1,000 crores revenue which will be substantially added to their bottom line. For RBI, such relaxation would translate into a reduction in SLR by about 1 % - 1 ½% which is not going to pose any risk to the banking system.In order to monitor compliance as to SLR requirements the banks may be asked to open a demat account and pool the securities which they propose to sell and transfer to the demat account of customers as and when the transaction takes place. The depositories can furnish independent reports to RBI about the SLR securities divested to retail investors by each of the banks.

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Interoperability:

The Depository for G-Sec is run by RBI which maintains records at ‘Nominee’ level as against ‘Beneficial Owner’ level maintained in CDSL/NSDL. As a result, the RBI at any point in time will have only the aggregate number of securities of each type held by a participant such as a bank, primary dealer, etc. and the individual beneficiary owner details are recorded only in the books of respective participant. Even in the books of RBI, the participant has to open Constituent Subsidiary General Ledger (CSGL) account in which all the securities held on behalf of the clients have to be maintained.

The Depositories namely CDSL and NSDL have also respective CSGL accounts with RBI and the transfer between one beneficiary owner in one Depository to another beneficiary owner in another Depository cannot happen without the change in the respective CSGL accounts maintained with RBI.

As many investors in the secondary market experienced a superior infrastructure with a transparent accounting process, they are not able to accept the transfer mechanism currently in existence for G-Sec’s. In fact the very nominee level accounting concept is not in tune with the times as CPSS-IOSCO report on Principles for Financial Market Infrastructures emphasizes on transparency and undisputed legal title to the security holder which presently a direct holding structure as existing in depositories can guarantee.

It is advisable for RBI to discard the SGL/CSGL system and ask the banks to hold and transact in G-Sec’s through CDSL/NSDL. As many banks themselves are depository participants, it will be a smooth transition from the existing layers of redundant processes to demat accounts for all their clients with clear title to security. With these three measures which are all doable at no additional cost to the exchequer, the RBI must give it atry. As it is said‘Failure does not lie as much in failure as in failing to try to be successful.”