let us make in-depth study of the reforms in Government securities market.
The Government securities market will gradually emerge as a vibrant segment of the Indian capital market.
Therefore, major reforms have been carried out in Government securities market since 1991 in tune with general policy of liberalisation, privatization and globalisation.
In the pre-reform period, through the medium of increase in statutory liquidity ratio (SLR), the banks were forced to invest in government securities at administered interest rate. In this way a large amount of bank resources were preempted by government through the medium of SLR.
Thus, Rakesh Mohan, the Deputy Governor of Reserve Bank of India, writes, “Prescription of a statutory liquidity ratio (SLR), though originally devised as a prudential measure, was used as the main instrument of pre-emption of bank resources in the pre-reform period. The high SLR requirement created a captive market for government securities, which were issued at low administered interest rates.”
Since 1991, a number of reforms have been undertaken to widen and deepen government securities market and to increase transparency in sale of these securities:
(1) First, the statutory liquidity ratio has been reduced over stages from 45 per cent to 25 per cent which is the statutory minimum liquidity ratio. With this a lot of bank resources have become available for lending to private sector. Of course, the banks, if they think profitable, can invest more than 25 per cent in government securities.
(2) In place of the system of administered rates on government securities, these securities are sold through an auction system. As a result, interest rates on government securities are determined at levels which are close to market rates of interest.
(c) To widen the market for government securities foreign institutional investors (FII) have been allowed to invest in government securities.
(d) Primary dealers (PD) were introduced as market makers in government securities markets. Besides, to ensure transparency in sale and purchase of government securities Delivery versus Payment (DvP) settlement system has been introduced.
(e) An important reform concerning trading in government securities is the Repurchase agreement (Repo) which is currently operated under the Liquidity Adjustment Facility (LAF) scheme. LAF scheme operates through repo and reverse repo auctions by RBI. The sale and purchase of government securities through repo and reverse repo operations are for only a short period, a day or few days.
When there is shortage of liquidity funds with banks Reserve Bank of India lends funds to them at a fixed repro interest rate through purchasing of securities from them for a very short period. On the other hand, when there are surplus liquid funds with the banks, they park these funds with RBI at a fixed reverse repo rate and in return get t
the government securities. Thus, in this way RBI is able to adjust and regulate the liquidity position of the banks.
source:google