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Financial & Banking Sector Reforms -
and Government Securities Market
In an earlier chapter we studied about the initiation of the Economic & Structural Reforms in our country in mid-1991, which heralded a new era in the economic history of our country. We will now consider the measures undertaken by the Government of India and RBI by way of Financial and Banking Sector reforms. Certain reforms in the financial sector were put through even before the onset of economic reforms in 1991. These measures were taken in 1985 based on the report of an expert committee constituted by RBI. This is the Report of Sukhmoy Chakravarthi Committee (1985), which in fact initiated the process of financial sector reforms in our country. This was followed by the report of the working group headed by Mr.N.Vaghul (1987). This is in the form of a follow-up report of the earlier Sukhmoy Chakravarthi Committee Report. In 1991 after the advent of the Economic Reforms, the recommendations of the Committee on Financial System (popularly called the Narasimhan Committee) provided the impetus for further initiatives. A second report was submitted by Mr.Narasimhan in the year 1987 signalled the need for the 2nd phase of Financial & Banking Sector Reforms.
Coverage of Financial Sector Reforms
What constituents of the Financial Sector were covered by reforms? The components of the financial markets that were chosen for effecting measures under the reforms are:
The Securities market (also called the debt market or Government securities market).
Objective of Financial Sector Reforms by Government
of India & RBI
To widen, deepen and integrate the different segments of financial sector, namely, the money market, debt market (particularly Government securities) and foreign exchange market.
Condition of Money Market in the pre-reform
period (before 1991)
- Financial system functioned in an environment of constriction, driven primarily by fiscal compulsions. It was geared to provide significant support for Government expenditure.
- The monetary and debt management policy was underlined by excessive monetisation of Central Government's fiscal deficit.
- Money and Govt. Securities market did not display any vibrancy and had limited significance in the indirect conduct of monetary policy.
- Money Market instruments were few
- Market had a narrow base and limited to a few participants - commercial banks and six all India Financial Institutions
- Rate of interest on money market instruments was regulated.
- Money market instruments consisted of Treasury Bills (91-days T-Bills) and term securities of different maturities issued by the Central and State Governments.
- The average maturity of securities remained fairly long, that is above 20-years, reflecting the preference of more the Issuers than those of the Investors
- Government borrowings were done at rates, which were far below the market rates. For example, for 30-year securities the interest rate was low at 6.5 per cent in 1977-78.
- The Policy led to distortions in the Banking System with high lending rates on certain segments combined with relatively low interest rates on deposits.
The Report of the Committee to Review the Working of the Monetary
System - 1985 (Sukkmoy Chakravarthi Committee)
The committee made several recommendations for the development of money and government securities markets. As a follow up the RBI set up the working group on money market (Chairman Mr.N.Vaghul), which submitted its report in 1987
The working group recommended a four pronged strategy to activate the money market.
- Attempt to be made to widen and deepen the market by selective increase in the number of participants
- An endeavour to be made to activate existing instruments so as to have a well-diversified mix of instruments suited to the different requirements of borrowers and lenders.
- A gradual shift from administered interest rates to market determined rates.
- to create an active secondary market for money and Securities, through a process of establishing new sets of institutions, which would impart sufficient liquidity to the system.
Follow up Measures initiated by R.B.I based on Chakravarthi Committee and
Vaghul Committee Reports during the period 1985-91
Measures taken to encouraging a secondary market in securities:
- Maximum coupon rate, which was as low as 6.5 per cent in 1977-78, was raised in stages to 11.5 per cent in 1985-86. Along with this the maximum maturity period was reduced from 30 years to 20 years.
- 182 days Treasury bills were introduced in November 1986 for the first time
- The Discount and Finance House of India Ltd. was set up in April 1988 as a money market institution jointly by RBI, Public sector banks and all India financial institutions, to develop a secondary market for money market instruments and to provide liquidity to these instruments.
Steps taken to strengthen Money Market
- Interest rate ceiling was completely withdrawn for all operations in the call/notice money market and also on rediscounting of commercial bills in May 1989.
- In May 1990 THE GIC, IDBI and NABARD were allowed to enter the Call Money Market as lenders. Also 13 financial institutions, which were already operating in the Bills Rediscounting Scheme, were granted entry in the call money market as lenders in October 1990.
- Certain other non-banking institutions were permitted in October 1991 to enter the call money market as lender through the DFHI (Discounting and Finance of India Ltd.
- New money market instruments viz. Certificate of Deposit (CD), Commercial Paper (CP) and inter-bank participation certificates entered the market in 1989-90. RBI framed guidelines for the issuance of these instruments.
Recommendations of the Committee on Financial System (the Narasimhan Committee)
A comprehensive package of stabilization and structural reform measures was initiated by the Government in mid-1991, in the financial sector based on the recommendations of the Narasimhan Committee. A second Report was submitted by Narasimhan in 1987 called as the Report of Narasimhan Committee II
Reforms with regards to Call, Notice, Term Money Market)
In pursuance of the recommendations of the Narasimhan Committee II, the RBI has a taken a decision to restrict the call, notice, term money market as a pure inter-bank market with additional access only to PDs. Steps have been taken to phase out non-bank participants from the market by granting them permission to operate in the repo market.
Reasons for the step
Since the withdrawal of the ceiling on the call rate, the call money rate has shown a tendency to fluctuate significantly on occasions. The sharp imbalances that arise in the demand and supply of money due to combination of several factors have led to such volatile behaviour. The most important of these has been bunching of banks' needs for short-term funds in order to meet the CRR compliance.
Earlier steps by RBI to reduce instability in the Call Money Market
In December 1992, RBI injected liquidity through the DFHI and the Securities Trading Corporation of India. In subsequent years, RBI has been moderating liquidity and volatilities through continuous use of repos and refinance operations and changes in the procedure for maintenance of CRR requirements.
Government Securities- Reform Process in Debt Management
As part of the reform process, debt management underwent significant changes. The principal objectives of Debt Management were defined as under :
to smoothen the maturity structure of debt
to enable debt to be raised at close to market rates
- To improve the liquidity of government securities by developing an active secondary market.
- To make the government securities market vibrant, broad-based and efficient in view of its role in setting a bench mark for the development of the financial market as a whole and bringing about an effective and reliable channel for the use of indirect instrument of monetary control.
Reforms in Primary market
Auction system of issuing securities has been introduced for both treasury bills and term securities since 1992-93, in order to pave the way for market related rates of interest for government paper.
The base for treasury bills market was widened with auctioning of different types, introduction of 364-day TB in April 1992 and 91-day TB in January 1993, and reintroduction of 182-day TBs in May, 1999.
- Funding of auctioned TBs into term securities at the option of holder as part of debt management.
- New instruments such as Zero coupon bonds, tap stock, partly paid tap and floating rate bonds were introduced.
- Bringing down the maximum maturity rate government securities from 30 to 20 years.
- Developments of instruments for repurchase o agreements (repos) between RBI and commercial banks beginning from December 1997.
- Since April 1997, a new approach was followed by the RBI in its open market operations that is, sale/purchase operations in government securities. In setting its price, the RBI responded to market expectations. It was also prepared to purchase certain securities in cash.
The effect of the above reform measures resulted in expanding the investor base gradually to non-traditional investors. The auction system contributed to a new treasury culture and progressive development of bidding and portfolio management skills.
Reforms in Secondary market in Government Securities.
- A phased reduction in SLR requirements from an effective 37.4 per cent in March 1992 to a little over 28 per cent in March 1996.It has since been reduced to the statutory benchmark level of 25%.
- The DFHI was authorised to deal in government securities in 1992-93
- The Securities Trading Corporation of India (STCI) was set up in 1994 by the RBI jointly with public sector banks and all India financial institutions with the main objective of fostering the development of the government securities market (It commenced operations in September 1994)
- Market transparency was achieved through regular publication of details of SGL transactions in Government securities put though Mumbai PDO since September 1994.
- After its establishment and becoming operational in June 1994, the National Stock Exchange provided secondary market treading facilities through its wholesale debt market segment.
- A system of Delivery Versus Payment (DVP) in Government securities was introduced in Mumbai in June 1995 to ensure that the transactions in government securities were fully secured.
- The Repo market has been activated by allowing repos/reverse repos transactions in all government securities besides treasury bills of all maturities.
- Non-bank entities which are holders of account with the RBI have been allowed to enter reverse repo (but not direct) transactions with banks/PDs
- With a view to encouraging Mutual Funds to set up gilt funds in government securities either by way of outright purchase or reverse repos to the extent of 20 per cent of the outstanding investments.
- Guidelines for satellite dealers in government securities market were announced in December 1996 And in April 1997 and the RBI granted approval to 17 entities for registration as satellite dealers in government securities, to promote/activate retailing in Government securities
Primary Dealers in Government Securities
Two institutions - DFHI and STCI were accredited as PDs in March 1996 and subsequently four more PDs were allowed to come into operation - SBI Gilts, PNB Gilts, Gilts Securities Trading Corporation, and ICICI Securities. A scheme for payment of underwriting commission was introduced in May 1997 replacing earlier scheme for paying nominal commission.
In March 1995 the RBI announced guidelines for setting up of primary dealers (PD) with the objectives of -
- strengthening the infrastructure of the government securities market in order to make it vibrant, liquid and broad based.
- Ensuring development of underwriting and market capabilities of government securities outside the RBI.
- Improving the secondary market trading system, which could contribute to price discovery, enhanced liquidity and to turn over and encourage voluntary holdings of government securities outside the RBI.
- Making PDs an effective conduit for conducting open market operations.
The full extent of notified amount of the dated government securities were offered for underwriting and the underwriting fees and amounts to be allowed to each PD prior to auction of each security. In respect of TBs, the PDs are required to give minimum holding commitments and fixed underwriting fees are paid for successful bids. The RBI granted liquidity support for PDs against their holding in SGL. Account.
Market transparency was established through regular publication of details of SGL transactions in government securities put through at Mumbai PDO since September 1994. The NSC which became operational in June 1994 also provided secondary market trading facilities through its wholesale debt market segment since 1994-95.
Guidelines for satellite dealers in the government securities market were announced in December 1996 and in April 1997. Satellite dealers in government securities are expected to activate retailing of government securities.
Satellite Dealer (SD)System Discontinued
In the Mid-term Review of October 2001, RBI announced its decision to undertake a review of the Satellite Dealer (SD) system in consultation with market participants. After obtaining the views of the Primary Dealers Association of India (PDAI) and after further discussions in TAC and considering their role in the present conditions, it has been decided to discontinue the system. Accordingly: No new SDs will be licensed. Existing SDs will be required to make action plans, satisfactory to RBI for termination of their operations as SDs by May 31, 2002.
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