Primary dealers eye new business model

16 of 17 dealers made trading losses in Q1.

PNB Gilts, which had posted a net profit of Rs 106.95 crore last year, recorded a Rs 83.63 crore net loss in the first quarter of this financial year. In the corresponding quarter of the last year, its net profit was Rs 48.44 crore.

PNB Gilts is not the only primary dealer that is in the red. An industry source says 16 of the 17 primary dealers in the country have made trading losses in the first quarter.

A few of them, however, have managed to post net profits, courtesy incomes from advisory businesses. Most of them made losses by trading in government securities in the April-June quarter of the year.

With interest rates moving up, primary dealers are in search of a new business model. A sub-committee of the Reserve Bank of India's technical advisory panel met on Tuesday to discuss this precisely. The technical advisory committee is a standing committee of the banking regulator on all market-related developments.

Once the sub-committee finalises its report, the RBI may allow primary dealers to diversify into other businesses, including foreign exchange derivatives, overseas bonds and commodity trading, to hedge their positions against adverse interest rate movements.

At least, the stronger primary dealers should be allowed at the first stage, a source said.

Collectively, primary dealers account for two-thirds of the primary subscription to government securities and a fourth of the secondary market volume. Primary dealers made a profit before tax of about Rs 1,470 crore in 2003-2004.

"Essentially, primary dealers are looking for a business model that will allow them to go short on interest rates. Since, they are unlikely to be allowed to go short on government bonds, they should take part in the interest rate futures market and take positions in foreign currency-denominated assets," said a source.

As capital market entities, primary dealers are required to maintain 15 per cent capital adequacy ratio on credit risk, besides an additional capital adequacy ratio on market risks.

The average capital adequacy of primary dealers is around 30 per cent now. They want to be allowed to deal in overseas bonds on the lines of banks and mutual funds.

In the foreign exchange market, they do not want to play the role of authorised dealers, which buy and sell foreign currency. Instead, they want to take positions in foreign exchange derivatives to hedge their interest rate risks.

"If the RBI does not allow them to diversify and spread the business risk, some of the PDs may be forced to surrender their licences and close shop," said the CEO of a bank which has a primary dealership arm.