Significance of Secondary Markets:
High liquidity and constant demand in the market need a diversified investor base with different preferences of demand, maturity and risk. Apart from the present players like banks, PDs and mutual funds, if the retail investors and foreign investors are also allowed to enter, the investor base can be widened. One of the significant aspects of the overall plan to develop a more diversified investor base is to meet the needs of retail investors, as it often reduces volatility in the market and ensures stable demand.
The liquidity in the secondary market can be increased by developing the repo markets, the role of benchmarks in the market valuation, and short selling in the market, etc. Some markets have prohibited the short selling of securities and the rationale behind this act should be recognized. Though the short selling has a positive effect on the liquidity and price efficiency in the market it may also increase the market volatility and risks particularly so if the market takes larger position than what it is capable of handling.
The RBI has initiated many measures to better the secondary market liquidity in the Government Securities market. Some of them allow a variety of participants, like reopening of bonds, Liquidity Adjustment Facility (LAF), repo market, setting up of Clearing Corporation of India Ltd., negotiated dealing system for trading, Delivery vs Payment system for settlement of Government Securities in scripless form, and communication of information relating to all Government Securities traded in the market on a daily basis.
Initially, the RBI was the announcer of the yield curve but now FIMMDA, a self-regulatory organization, announces the yield curve, based on a methodology that is approved by the RBI. Incidentally, banks are holding around 37% of their liabilities in Government Securities as against the Statutory Liquidity Ratio (SLR) of 25 percent. The Reserve Bank of India (RBI) has taken steps and given a direction to banks to achieve the targeted reserve created for investment fluctuation.