State Bank to merge PD arm

State Bank of India (SBI) will set the ball rolling for merger of standalone primary dealers (PDs) with the promoter banks.

The country's largest commercial bank proposes to merge its primary dealer subsidiary SBI-DFHI with itself. Banking sources said SBI has already discussed the proposal with the Reserve Bank of India (RBI), but no decision has yet been taken.

The sources said Citibank, Standard Chartered and HSBC also have plans to absorb their PDs. Foreign banks, too, are understood to have decided, internally, to merge their respective PD arms, but they have not yet submitted final proposals to the central bank.

Primary dealers underwrite auctions of government securities and also create a market for secondary sales of these papers by offering two-way quotes.

The RBI allowed banks to merge their respective PD arms with themselves in order to create a higher capital base.

The capital base is required, as these primary dealers will be solely responsible for underwriting the government borrowing programme in the new regime under the Fiscal Responsibility and Budget Management Act, with effect from April 1, 2006.

This means that if an auction fails to get fully subscribed, PDs would step in as underwriters and help the government carry out its borrowing programme.

Thereafter, PDs can offload the government papers in the secondary market. Under the current structure, it is not possible for PDs to fully underwrite government bond auctions as they are undercapitalised.

Primary dealers run into losses everytime interest rates go up. Under the new regime, banks with PDs as a division will be given incentives in terms of fees for underwriting the government borrowing programme.

From April 1, 2006 onwards, Clearing Corporation of India Ltd will be conducting government bond auctions. The RBI will, however, continue to decide the cut-off rates at which bids at government bond auctions will be accepted.