Transactions in the Government Securities by NBFCs

Vaibhav Rathi

30 Mar, 2024

Transaction in government securities refers to any buying or selling of government-issued securities. Government securities, usually referred to as government bonds or sovereign bonds, are financial instruments issued by a government to raise money for a variety of uses, including financing public projects or balancing the budget. As part of their investment and portfolio management activities, Non-Banking Financial Companies (NBFCs) are permitted to conduct transactions with government securities. Let us discuss the transactions in government securities by NBFCs.

Non-Banking Financial Companies

A Non-Banking Financial Company (NBFC) is a business registered under the Companies Act of 1956 engaged in the business of making loans and advances, acquisition of debentures/shares/bonds/stock/securities issued by the Government or local authority or others. Marketable securities of similar nature, hire-purchase, leasing, insurance business and chit business. It does not include establishments whose main business is industrial activity, agricultural activity, buying or selling. A non-banking financial company (Residuary Non-banking Company) is an organization whose primary activity is the receipt of deposits under any scheme or arrangement, whether in a single payment, as instalments through contributions, or in any other method.

What is a Government Security (G-Sec)?

 A tradeable instrument known as a Government Security (G-Sec) is one that the Central Government or State Governments have issued. It accepts the Government’s debt obligation. These securities can be long-term (often referred to as government bonds or dated securities with original maturities of one year or more) or short-term (typically referred to as treasury bills with original maturities of less than one year). In India, the State Government exclusively issue bonds or dated securities, known as State Development Loans (SDLs), while the Central Government issues both Treasury Bills and Bonds or Dated Securities. G-Secs are referred to as risk-free, gilt-edged instruments since they have almost no default risk.

Transactions in Government securities by Non-Banking Financial Companies

According to the Non-Banking Financial Company–Non-Systemically Important Non-Deposit taking (Reserve Bank) Directions, 2016, each applicable NBFC shall, as the Bank may permit, engage in transactions in Government securities through its gilt account, its demat account, or any other account.

Gilt Account: With the exception, a Gilt account is similar to a bank account. It is that government securities, such as Treasury Bonds, are credited or debited to the account rather than actual money. It serves as a savings account for government securities. Government security, or G-Sec, is an exchangeable document that the federal, state, or local governments provide to verify debt repayment. Due to the nearly minimal default risk they carry, G-Secs are sometimes known as risk-free securities.

The institutions that the RBI has approved as holders of Gilt accounts include NBFCs, pension funds, mutual funds, provident funds, cooperative banks, trusts, insurance companies, regional rural banks, corporates, and non-NDS members.

Demat Account: A Demat account, also known as a dematerialized account, allows for the electronic storage of shares and other securities. Shares are purchased and maintained in a Demat Account during online trading, making it simple for consumers to transact. All of a person’s investments in bonds, mutual funds, exchange-traded funds, shares, and government securities are kept together in a demat account.

Transactions where NBFCs are engaging in Government Securities

 Through a variety of transactions, Non-Banking Financial Companies can take part in the market for government securities. Here are a few typical interactions between Non-Banking Financial Companies and government securities.

• Investment: Non-banking financial Companies may invest their surplus funds in government securities. These securities are regarded as risk-free investments and can offer NBFCs a reliable source of revenue.
• Portfolio Management: NBFCs can handle client investment portfolios, which may contain holdings in government securities. This enables clients to take advantage of NBFC’s experience in managing their investments.
• Trading: As traders, NBFCs may buy and sell government securities. To make money, they can profit from changes in interest rates and price levels.
• Underwriting: Some NBFCs might take part in the underwriting of government securities issuances. This entails committing to buy a specific percentage of the securities being offered and reselling them to investors afterwards.
• Market Maker: NBFCs have the ability to serve as market makers for government securities. By offering to purchase and sell securities at specified prices, they give liquidity to the market, assisting in more seamless trade. 
• Advisory services: Clients interested in investing in government securities may contact NBFCs for advisory services. This involves giving information on market trends, changes in interest rates, and investment tactics.
• Repurchase Agreement: NBFCS are permitted to carry out repo transactions involving government securities. This effectively acts as a short-term borrowing mechanism and entails selling securities with the intent to buy them back later. 
• Asset Management: NBFCS are able to oversee the portfolio management of mutual funds and other investment vehicles that hold government securities.

Conclusion

Transactions involving government securities help financial markets operate effectively, enable the Government to raise funds and allow Non-Banking Financial Companies to invest in secure assets that will generate income. It is crucial that Non-Banking Financial Companies dealing with government securities follow the rules and regulations established by the appropriate regulatory bodies, RBI and SEBI. These rules ensure transparency, fair practices, and the stability of the financial system.

 FAQs: –