STRIPS in the Government Securities Market

STRIPS is a process of stripping a conventional coupon bearing security into a number of zero coupon securities which can be traded separately. To illustrate, a 10 year government security can be stripped into a principal component and a set of 20 individual coupons/assuming half yearly coupon payments. Each of these 21 stripped securities can be treated as zero coupon bonds which can be traded at varying yields.

The conversion of one underlying security into a number of zero coupon securities called STRIPS increases the breadth of the debt market and provides a continuous market which ultimately helps in improving liquidity. The creation of securities of varied maturities from a single security satisfies the needs of different investors who have diverse risk profiles and investment horizon. STRIPS benefits not only investors, but also issuers. STRIPS allow the issuer to issue securities with long term maturity for any amount. These long term securities can be stripped to meet the market needs for short term securities. Moreover, the supply of securities increases with stripping and this boosts the secondary market activity. Further banks can issue STRIPS against the securities held by them. Thus, STRIPS facilitates the management of the banks’ asset liability mismatches.

The Reserve bank of India’s policy of re-issuance of existing loans and alignment of coupon payment dates across loans facilitating creation of volumes in certain benchmark securities is creating am environment for STRIPS. The secondary market volumes have increased and the market has the requisite size to make STRIPS a success. The necessary provisions have been made to facilitate the introduction of STRIPS in the Government Securities Act which is to replace the existing Public Debt Act, 1944.

Relating of Government Securities:

The existence of strong retail segment is a prerequisite for the development of the government securities market. Individuals can buy government securities from the Reserve Bank’s public debt office during auctions. However, most investors are not familiar with the functioning of the government securities market and most of them perceive government securities as an instrument meant for institutional investors. Owning to this, the retail market of government securities did not develop. The Reserve Bank has made efforts to promote retailing off government securities.

Banks are allowed to freely buy and sell government securities on an outright basis at prevailing market prices. They retail government securities to non-bank clients without any restriction on the period between sale and purchase. Further, the interest income on government securities was exempted from the provision of tax deduction at source with effect from June 1997 to facilitate genuine trading in the secondary market. With no TDS, government securities become an attractive investment for those interested in avoiding TDS such as senior citizens.

One of major objectives of setting the primary dealer system and satellite dealer system was to increase the distribution channels and encourage voluntary holding of government securities among a wider investor base. The Reserve Bank has extended to them a scheme for availing liquidity support and the facility for repos (as lenders) for increasing the retail network.

A few banks and primary dealers have taken useful initiatives to promote retail investment in government securities by offering these securities for sale at retail outlets. However, not much has been achieved by these efforts. Banks have been reluctant to market government securities to retail investors apprehending the creation of an adverse pact on their own deposits. Moreover, not much headway has been made in retailing government stock by NSE, NSDL and so on which were given the facility of a second SGL account.

It is the primary dealers who can effectively build awareness regarding the advantages of holding government securities. They should be given all infrastructure support to create a retail market for government securities. PDs and banks may also provide both sale and purchase facility to ensure that retail investors are assured of liquidity of such investments. Besides these, the stock exchange network can be used to expand the retail segment of the government securities market.