At present there is not much of an outlet for the investors"" notably banks and financial institutions"" in PSU bonds and other debt instruments, as the secondary market for them hardly exists. Banks thus have a mammoth Rs 15,000 crore as dead investment on their hands. Repo deals could provide them with greater liquidity.
Says Vishnu Deuskar, country treasurer at ABN Amro Bank: "Investors in securities are exposed to price risk without any form of hedging available, as also lack of liquidity and depth in the market for some instruments. This means that once a security is purchased, the investor is often not able to sell for want of a market. The repo provides an ideal solution as it reduces price risk and provides refinancing of assets whenever required."
Moreover, with the thirty-day bank deposits being the minimum duration for which interest is paid, investors with surplus funds for a shorter duration would be compelled to keep them idle in the absence of suitable avenues of deployment. Investing them in securities would expose them to price risk. Here again, repos would serve a useful purpose, Deuskar adds.
From the central bank's view point, however, the existing opportunities for repo transactions in treasury bills and dated securities are enough to afford the required liquidity for banks. Securities worth Rs 80,000 crore are said to have repo facilities, and banks have not been utilising these limits to the full. Currently, repo transactions amount to less than 50 per cent of available opportunities, so where is the need for expansion of the list, argues the RBI.
But this may not always be true. "The repo market is closely linked with call rates. When the call market goes up, the number of repo transactions too register an increase, and the interest rates are near the call rates," says B Lakshminarayana, senior manager of Gilts Securities Trading Corporation.
A regulated market
But this is not the most important issue. What is really crucial is whether the RBI should continue to treat the repo market "" an essential part of financial markets "" with such an iron hand in the post-liberalisation era.
Ever since the securities scam took place and the Janakiraman Committee submitted its report, the RBI has been strictly regulating the market. It has banned repo transactions in all dated securities issued before 1993; it has also banned repos with parties other than banks. It does not allow repos for a period less than three days. And it disapproves of what it calls "deemed repos".
These are essentially sell and buy back transactions in which the second leg "" the repurchase "" takes place at market related rates. So, in theory, sell and buy back transactions are allowed, provided they take place at market related rates, with a gap of at least thirty days between the two legs of the transaction and the types and amount involved are not
similar.
But in reality, hardly any
transactions of this nature take place in the market because the banks are afraid of the RBI's wrath. "The RBI actually discourages banks from undertaking such deals," says a treasurer with a
private sector bank.
Market players insist on more freedom for the repo market. "Not only banks but also the corporates and the NBFCs should be allowed to play in this market," says Deuskar. It will provide better liquidity, he adds. However, the general perception is that matters may not improve soon. "This is a strong hangover of the security scam and will take quite sometime for the RBI to put it behind and go forward with what the market wants," says Ashish Pitale, manager-debt research, at ICICI Securities and Finance Company Ltd.
Inadequate infrastructure
The RBI however has a different story to tell. The central bank's
version is that unless an adequate settlement system is in place, repo transactions in PSU bonds may lead to a repetition of the security scam.
As far as government securities are concerned, the RBI has developed the subsidiary general ledger (SGL) system of settlement for repo trades. SGL is basically a depository system which ensures scri- pless trading. An important component of the SGL system is the delivery versus payment (DVP) system, wh- ich ensures that no transfer of security from one account to another takes place unless the payment for the transaction has been cleared. In short, it is a foolproof system of trade settlement involving banks, fi- nancial institutions and other investors in government sec- urities. Every bank has a current acco- unt with the RBI which is credited or debited as the case may be in repo transactions.
RBI sources say that unless a similar system for clearance and settlement of repo transactions in PSU bonds is established, it wou- ld be extremely difficult to allow such transactions. In fact, an attempt was made to set up a system on these lines for the bonds two years ago in conjunction with the Stock Holding Corporation of India, but for some reasons that did not work out.
Another problem is that the certificates of these bonds take a long time for issuance. Cases have been reported where even after a year, the physical deliveries of the certificates were not made by the PSUs issuing them. In such cases, it would be very difficult to keep a record of sales and purchases of these bonds by banks, something akin to what was happening before the the scam.
Who is the regulator
Curiously, an additional problem relates to the authority for regulating these transactions in PSU bonds. As far as government securities are concerned, the RBI is the natural regulatory authority because it is the issuing authority. However, should the PSU bonds too come under its purview? The RBI is concerned only to the extent that banks are major subscribers to them, but should this make it a natural regulatory body? The point is definitely debatable.
One school of opinion is that the Stock Holding Corporation of India Ltd (SHCIL), set up as a depository, should be assigned this task. And if the SHCIL is assigned the task of settlement in PSU bonds, will the RBI have any authority over repo transactions in them? The obvious answer is, yes, as far as banks are concerned. But what about other major investors, like for example, the UTI? Can the RBI stop them from undertaking repo transactions in PSU bonds?
And here is the most amusing part. The very legality of repo transactions, whether in government paper or in other securities, is open to doubt. The Securities
Contract Regulation Act (SCRA) specifically bans repos in all kinds of securities. The RBI has been permitting such transactions under the RBI Act. How far this is valid is a legally debatable issue which could well open up a Pandoras' box.
The clash between the two Acts may one day come up when the authorities will have to take a comprehensive look at the whole gamut of issues. Until that is done, the path to repo transactions in PSU bonds and other securities will by no means be smooth.