About a two decades ago in 2000, when the SBP started the primary dealership (PD) for government bonds and papers issuance, the objective was to broaden the market base and to have players other than banks that become significant participants in government securities. However, for one reason or the other, two decades down the lane, 75 - 80 percent of government marketable securities are still held by banks.
There are a few reasons for lack of market development. One is the allowance of inherent free put option in NSS investment by retailers, and on and off for institutional investors. The other reason is the dominance of banks in the primary dealership. Due to the second reason, SBP has recently issued a circular outlining the master rules governing the primary dealership system.
The crux of the effort is to break the banks’ dominance; especially in a yet to be amended SBP Act where there will be absolutely no room for direct government borrowing from the central bank. It has been observed that historically (especially in the recent quarters), banks have dominated the market rates and their greed has cost the government and other investors.
Interest rates in Pakistan are highly volatile – banks want to buy bonds at peak rates (such as 13-14% in 2019) and sell at falling rates (such as 7% or so). A few other players – such as insurance and mutual funds, are also used (or abused) by banks. It is hoped that dominance and monopolistic structure shall be broken.
In the new rules of the game, SBP has decided to issue two new categories of dealers in addition to full-fledged primary dealers (PDs). These categories are preliminary primary dealers (PPDs) and special purpose primary dealers (SPPDs). There exists 12 PDs with 11 out these 12 are banks with one DFI. There used to one broker (JS) as a PD; but incentives were there for big banks, and that one small fish left the ponds full of sharks.
Now SBP is making a pool for small and medium size fish to operate. The objective is to open the market for capital market players. Though they were eligible for PD ship, the conditions were too stringent while returns were not good enough – that is why JS left earlier. Although under the new circular, conditions for PDs are tightened further, lesser stringent conditions are applied for PPD and SPPD to come and play.
For PPD, the paid-up capital is less which lowers the obligations and the underwriting commitments, along with less quoting obligations. This shall encourage the brokers to come into action.
Another interesting aspect is that each PD must provide a business plan. The scope within banks is widened beyond treasury operations. Small group of bankers earn majority of banks’ profits and ironically, they take pride in it. Now for PD CEO and consumer heads and others shall be signatory on the business plan. This shall encourage banks to have retail and institutional investors in the government securities.
Right now, banks run a blatant business model where branches function like shops to seek cheap deposits (CASA) and let the small bunch of machos in treasury to make money. SBP is trying to end this practice. But to attract retail investors, the inherent free put option in NSS must end. The way it is done for institutions.
In early 2000s, when institutions were banned from investing in NSS, there was a case of development of TFCs and commercial papers market. Later, due to volatility in rates and economic conditions along with allowance of institutions again in NSS, the nascent market was killed. Now, there is an intention to develop this market again.
The key is to bring corporate into the capital debt market. There are very few provident funds and gratuity funds where proper interest rate management takes place. The category of SPPD is for central depository and national clearing companies (such as CDC and NCPPL) to become dealers on behalf of their clients. This is to bypass banks and will not let banks to front run clients’ strategy.
The other interesting element in new rules for PDs is the minimum participation requirement of 5 percent of target for each auction. This implies between 12 PDs, there will be participation of at least 60 percent of the targets.
The bottom line is that SBP’s intention is to let the debt capital market to deepen and to take government out of the shackles of banks. Lets’ see how successful this attempt would be.
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