RBI PERMITS LENDING, BORROWING IN G-SEC

The Reserve Bank of India (RBI) recently issued directions, known as RBI (Government Securities Lending) Directions, 2023, permitting lending and borrowing of G-Securities (G-Secs).

1. Government Securities Lending (GSL): A GSL transaction involves the lending of eligible government securities by a lender to a borrower for a specified period.

• G-Sec is a tradeable instrument issued by the Central Government or the State Governments.
• They include short-term Treasury bills (T-Bills) and long-term Government bonds or dated securities.
• Central Government issues T-Bills and bonds, while State Governments issue bonds known as State Development Loans (SDLs). G-Secs are considered risk-free due to minimal default risk.

2. G-Secs issued by the Central government, excluding Treasury Bills (T-Bills), are eligible for lending/borrowing.
3. Both G-Secs issued by the Central Government (including T-Bills) and State Government bonds are eligible as collateral.
4. G-Secs are auctioned via RBI's electronic platform called E-Kuber.
5. Other G-Securities

• Cash Management Bills (CMBs), introduced in 2010, are short-term instruments to manage temporary cash flow mismatches.
• CMBs resemble T-bills but have maturities less than 91 days.

Other Directions Include:

1. Eligible Participants: Entities eligible for Repo transactions and those approved by RBI can participate as lenders of securities.

• A repurchase agreement (repo) is a short-term borrowing option for government securities dealers. 

2. Tenure: Minimum one day with a maximum period for short sales coverage.

Benefits of Permitting Lending and Borrowing of G-Secs:

1. Permitting lending and borrowing of G-Secs aims to enhance depth and liquidity in the G-Sec market, facilitating efficient price discovery.
2. It also aims to encourage wider participation, allowing investors to deploy idle securities, improve portfolio returns, and boost operational efficiency of government bonds by insurers.

Benefits of G-Secs

1. Low-risk investments backed by the Government.
2. Provide stable income with fixed interest rates.
3. Securities like State Development Loans (SDLs) and Special Securities offer attractive yields.

• SDLs are bonds issued by state governments to fund their fiscal deficits. The RBI manages the issuance of these bonds.

4. Integrating G-Secs in an investment portfolio helps reduce overall risk.
5. Easily tradable, allowing quick buying and selling.
6. Used as collateral for borrowing funds in the repo market.

Initiatives for G-Secs

1. G-sec Acquisition Programme (G-SAP): RBI conducts open market operations to purchase G-Secs, reducing market volatility.

• Open Market Operations (OMOs) are a monetary policy tool used by central banks to regulate the money supply and liquidity in the financial system.

2. RBI Retail Direct Scheme: Allows retail investors to open and maintain 'Retail Direct Gilt Account' (RDG Account) with RBI for G-Sec platform access.

• A Retail Direct Gilt (RDG) account is a free, online account that allows retail investors to buy and sell government securities.

3. Draft RBI (Bond Forwards) Directions, 2023: Introduces bond forwards in G-Secs, allowing long-term investors to manage cash flows and interest rate risks.
4. Scheme for Non-competitive Bidding Facility: Encourages retail participation in primary market auctions for G-Secs and SDLs.

Mitigating G-Secs Risks Techniques:

1. Hold securities till maturity to avoid market risk.
2. Manage market risk and reinvestment risk through Asset Liability Management (ALM) by matching cash flows with liabilities.

• Asset and liability management (ALM) is a strategic approach to managing financial risks that arise from mismatches between assets and liabilities.

3. Rebalance the portfolio by selling short-term securities and buying longer-term ones to manage portfolio risk.
4. Employ advanced risk management techniques like Interest Rate Swaps (IRS) to alter cash flow nature. An Interest Rate Swap (IRS) is a contract between two parties to exchange interest rates over a period of time.

Concerns and Solutions:

Concerns	Solutions
G-Secs primarily held by captive investors like banks and insurance companies limit market liquidity.	Integration of G-Sec and corporate bond markets enhance pricing information transmission and market efficiency.
RBI's Negotiated Dealing System - Order Matching (NDS-OM) platform fails to enhance retail participation, leading to segmented investor markets.	Issue and trade G-Secs through stock exchanges to promote retail participation and ease of transactions.
Inflows of foreign funds via government bonds may appreciate the rupee.	Dematerialize G-Secs for easy investment by demat holders and develop G-Sec-based exchange-traded funds to increase retail participation.
Limited liquidity in the G-sec market results in distressed sales and losses for sellers.	Outline a transparent fiscal path under FRBM legislation to boost investor confidence.
Adverse price changes due to interest rate fluctuations may lead to losses upon selling.	Provide tax exemptions on interest income from G-Secs to stimulate market demand.

Related News: State Government Guarantees (SGGs)

1. The 32nd Conference of State Finance Secretaries in 2022 addressed concerns about inadequate monitoring and reporting of state government guarantees. A Working Group was established in response to these concerns.
2. RBI published the Report of the Working Group on State Government Guarantees (SGGs).
3. SGGs are contingency measures shielding investors or lenders from borrower default risk.
4. State governments issue guarantees for state enterprises, cooperative institutions, urban local bodies, and other state-owned entities, typically to commercial banks or financial institutions.
5. Guarantees pose fiscal risks, straining state finances with unexpected cash outflows and increased debt. High guarantee levels not disclosed can understate (downplay) a state's debt-GSDP ratio.
6. Recommendations by RBI Report:

• Clearly define the purpose of government guarantees.
• Impose a minimum fee for guarantees.
• Set a ceiling for annual incremental guarantees at 5% of Revenue Receipts or 0.5% of Gross State Domestic Product (whichever is less).
• Encourage states to contribute to the Guarantee Redemption Fund (GRF) to manage liabilities due to guarantee invocation. Currently, 19 states have established GRFs.

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