Deepening financial markets: Panel explores reviving instruments banned after 1992

0 inShare MUMBAI: The banking regulator, high-street lenders and bond houses have come together to exorcise the ghost of the Harshad Mehta securities scam. In an aim to deepen financial markets, they are trying to reach a meeting point to introduce more room for short-selling of government securities, longer holding periods for bonds in trading books, and bring back the once-famous double ready forward deals that were prevalent prior to the '92 scam. Some of these transactions were banned out of a regulatory paranoia that had set in following the parliamentary panel report on the scam. Since then a generation has passed, new players have stepped into the money market, checks and balances have been put in place and antiquated systems have given way to new technology. Today, financial institutions and regulators are actively considering ways to allow greater trading flexibility, make the market liquid for lenders and borrowers, and give banks a chance to protect their huge bond investments that lose value when interest rates surge. A central bank-constituted panel comprising senior RBI officials, bankers, and heads of other intermediaries are discussing ways to bring about the change. The team is expected to submit its initial report in April. /photo.cms?msid=12374960 "Double ready forward deals earned a bad name as traders took advantage of a lagged, manual recording system in days of physical securities to divert money to stocks. There is no reason why they should not be reintroduced. Today, they will help to create the much-needed term money market and encourage institutions with surplus cash to lend for longer periods," said the head of a financial institution. At present, money market lending through repos - or repurchase of securities - is largely overnight. In an overnight repo, a lender buys a security from the borrower at Rs x and sells back the next day at Rs x plus y. Banks and mutual funds are reluctant to commit money for more than a day due to fears of sudden fund requirement and redemption pressure. Developing Term Money Market But if a lender having entered into a 7-day repo is in need of funds after two days, and has the flexibility to use the security it has bought to enter into second repo to borrow money from another institution, it will not face a crunch. Such trades will enable institutions and corporates to lend for a week, fortnight or even a month through repo deals. Such transactions, better known as double ready forwards, will benefit treasuries and develop a term money market by making it convenient for borrowers and lenders available for various durations. Another possible relaxation discussed by the panel is allowing a higher limit for short-selling. Currently, banks and primary dealers can short sell 0.25% of the notional outstanding stock of a particular government bond. The suggestion is to allow higher short-selling to hedge interest rate risks and protect loss on securities that are being held when rates are rising. This will simultaneously require expanding the floating stock of bonds. A sizeable portion of a bond is held by banks in their 'held to maturity' basket (where securities are not mark to market), and institutions like provident funds and insurance companies that are not active traders. Reissuance of bonds, some trading by retirement funds and a transition of banks to an accounting system where all securities are mark to market will increase the floating stock of various bond and increase liquidity More importantly, this will also ensure that short-selling does not result in a short squeeze in the market.