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RBI to announce STRIP rules
January, 12th 2010

The Reserve Bank of India will announce rules for the so-called STRIPS trading in government debt by January-end and issue floating rate bonds worth Rs 18,000 crore by March to increase the depth of the debt market and enable banks to manage their portfolio risks better, a central bank official said.

STRIPS, or Separate Trading of Registered Interest and Principal of Securities, is the process of separating principal and interest payments on bonds to turn them into zerointerest securities. "The guidelines for STRIPS are finalised and will be notified soon, said the official, requesting anonymity , adding that the notification on auction of the first tranche of floating rate bonds is expected within a fortnight.

These developments come ahead of a meeting scheduled on Monday with primary dealers, where the RBIs internal debt management office will seek suggestions to launch cash default swaps, in which a buyer who pays a seller receives in exchange a payoff for defaults. The meeting, coming after two months, assumes significance as it is the last before the central banks much-awaited monetary policy on January 29.

The RBI had released the draft guidelines on STRIPS on May 14, 2009 and had said in April it will issue the final rules in the year ending March 31. RBI had said in the draft norms that bonds with maturity dates of January 2 and July 2, irrespective of the year of maturity, will be eligible for stripping. Primary dealers and treasury heads of banks welcomed the move to issue more floating bonds as well as the STRIPS norms.

"We have raised the demand in three meetings with the central banks internal debt management department before they issued the first tranche of bonds worth Rs 2,000 crore on December 18," the head of a primary dealership said.

Banks face asset-liability mismatches when costs and returns of funds fluctuate. Floating rate bonds so-called as their interest rates are pegged to a benchmark such as the treasury bill rate and adjusted periodically help them to hedge this risk to a certain extent as the return changes in tandem with the interest rate to which it is pegged.

Private and foreign banks typically lap up floating rate bonds for the same reason. Interest rate of bonds worth Rs 2,000 crore that will mature in 11 years were linked to that of 182-day treasury bills. While it was pegged at 3.79% for the first six months, the interest, or coupon, will be reset every six months as per the average yields of the last three auctions of 182-day treasury bills.

Banks also do not have to provide for losses on floating bonds under mark-to-market provisioning norms that give a realistic appraisal of an institutions current financial situation. Bond yields and prices move in opposite directions.

Banks have to provide for losses or profits every quarter after marking the prices at which the bonds were acquired to the closing rate on the last trading day of the quarter. The benchmark 10-year bond has seen hardening of yields by over 2.5 percentage points last year.

While the floating rate papers are not usually traded as there is little chance of a loss in such debts, the introduction of STRIPS is likely to trigger high volumes in government debt. Currently, 10 floating bonds worth Rs 43,350 crore are in circulation.

Of the governments budgeted borrowing of Rs 4.92 lakh crore for the current year, more than 85% is completed as of now. The next auction is Rs 8,000 crore of treasury bills on Wednesday and Rs 10,000 crore of government bonds on Friday.

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