Central Bank ups primary dealers’ minimum capital to Rs. 2 billion

• New directives include setting up special risk reserve comprising 10% of after-tax profit as well as conditions when distributing profits
• In 2020 primary dealers reported Rs. 4.9 b in after-tax profit up from Rs. 3.8 b in 2019

The Central Bank has increased the minimum capital of primary dealers to Rs. 2 billion from January next year from Rs. 1 billion at present. 

From 2023, the minimum capital requirements will be Rs. 2.5 billion.

Risk Weighted Capital Adequacy Ratio (RWCAR) of primary dealer companies as at end-2020 was well above the minimum required amount of 10% despite marginal decline to 27% from 27.6% in 2019.

As per the new directives issued effective 1 August, primary dealers will be required to set up a Special Risk Reserve (SRR) to promote the safety, soundness and the stability and build capital base. The primary dealers are required to transfer 10% of after-tax profit annually to the SRR.

The need for sound capital assessment and planning process which determines the level of capital has been stressed as well and a buffer to be maintained against all material risk exposures which can be reliably quantified under normal and stress conditions. 

The primary dealers should develop a capital plan with time targets approved by the Board of Directors for at least three years. This plan should stipulate means by which the company intends to meet its current and future capital needs in line with strategies, risk profile and regulatory requirements. The plan should capture the future expansion, other sources of funds, distribution policies and potential uncertainties. 

Where a company maintains the core capital at below Rs. 2.5 billion as at the effective date of latest directions or at any time thereafter and if such shortfall persists for over three months, the company should within three months submit a time-bound plan for capital augmentation.

Each company should have a distribution policy approved by its Board which stipulates the criteria for making distribution of its earnings. Prior approval of the Director of Supervision of Non-Bank Financial Institutions is required if a company is making distribution under select circumstances. 

One is accumulated distribution for the period which such distribution relates to (including proposed distribution) exceeds Profit After Tax or a company has incurred a cumulative loss for the period or making the distribution requires the use of earnings of prior years or accumulated earnings of prior financial years remain negative before or after the proposed distribution or core capital remains at a level below of Rs. 2.5 billion before or after the distribution. 

When a company decides to make a distribution for an interim period or prior to availability of annual audited accounts it should retain 10% to the SRR. 

Among other requirements are a primary dealer should not enter into transactions with any counterparty with a view of undue transferring of profits or losses of the company. 

As at end-2020, there were six Licenced Commercial Bank (LCBs) and seven Primary Dealer companies appointed as Primary Dealers (PDs) in the Government securities market.

As per Central Bank data, total assets of PD companies increased by 12.4% to Rs. 87.2 billion in 2020. 

The total investment portfolio of government securities, consisting of trading, available for sale and held to maturity portfolios amounted to Rs. 80.1 billion at end-2020, recording an increase of 15.5% during the year. 

The trading portfolio increased to Rs. 62.6 billion by end-2020, from Rs. 57.5 billion recorded at end-2019 while the held to maturity portfolio increased to Rs. 14.7 billion at end-2020 from Rs. 8.6 billion at end-2019. Available for Sale Portfolio decreased to Rs. 2.8 billion by end-2020 compared to Rs. 3.3 billion as at end-2019. 

PD companies reported Profit After Tax of Rs. 4.9 billion during 2020 against that of Rs. 3.8 billion during 2019, indicating a significant improvement in profitability consequent to the decline in yield rates. The significant increase in capital gains recorded in 2020 compared to 2019 has largely contributed to the increase in profits despite the mark-to-market loss recorded by PD companies in year 2020. 

Consequently, Return on Assets (ROA) and Return on Equity (ROE) of PD companies increased to 7.6% and 30.5%, respectively, by end-2020 from 6% and 28.5% recorded in 2019, respectively.

Equity of PD companies increased by 11.2% largely due to the accumulation of profit during the year. The Risk Weighted Capital Adequacy Ratio (RWCAR) of the PD companies was well above the minimum required amount of 10% despite a marginal decline to 27% as at the end-2020 from 27.6% reported as at the end-2019.

The proportion of trading portfolio to the total investment portfolio of PD companies decreased marginally and was recorded at 78.2% as at end-2020 compared to 82.9% as at end-2019, reflecting a marginal decrease in the relative market risk exposure of the industry.

The overall liquidity risk exposure of PD companies increased due to the increase in overnight negative mismatch in the maturity profile of assets and liabilities of the PD companies by end-2020. 

The overnight negative mismatch increased to Rs. 13.1 billion or 79.5% of the overnight liabilities as at end-2020, from Rs. 11 billion (72.1%) as at end-2019. In view of holding a large volume of government securities, which are free of credit risk, by PDs and also the ability to use such Government securities as collateral for obtaining funds to bridge any unforeseen liquidity gaps, the liquidity risk profile of PDs remained low throughout the year except for one PD who was facing liquidity issues.

Most of the PDs had stand-by contingency funding arrangements to bridge any liquidity gaps.