By the term debt capital market we mean a fixed income market where trading of debt securities like bonds and loans are carried out. Both businesses and governments rely on debt capital markets or equity markets to raise funds necessitated for growth or expansion.
However, it needs a note that unlike debt capital markets those who purchase equity happen to be owners whereas those who purchase bonds are lenders. The lenders are eligible for a fixed rate of interest. It is generally sub divided into primary and secondary markets. Borrowers use the primary market to raise funds from investors by launching a new bond. Secondary markets are primarily used for trading existing bonds among different entities. Government agencies, hedge fund owners and investment bankers carry out such trading activities. In both markets fixed trading of the securities happens, although the rates of interest may vary.
Companies or business houses in need of money approach investment banks. Investment banks specialise with debt capital management and also assist with bond issues. The investment bank involved in debt capital management is termed as originator. As a reward for its services the investment bank charges a hefty amount as fees. It also deals with cross country swaps.
A secondary market is devoid of any intermediaries. Here one can buy and sell debts. Secondary markets mainly handle government bonds issued with the sole purpose of raising money from the public. The government requires this money to carry out its developmental activities. Business houses are in constant need of capital for expansion of business growth. There are two avenues to companies to raise capital – debt capital market and equity capital market. Equity capital market dominates the scene due to the presence of high volumes of IPO and investment banking.
Debt capital market is an amalgamation of investment banking and sale and trading of bonds. Companies rely on debt capital markets for urgent needs of funds. Business entities need to shell out a certain amount as interest on these securities. Debt capital markets rule out any decline in stock holding or decrease in ownership. Due to their “higher volume but lower margins” debt capital markets are popular.
There is a larger volume of transactions in a debt capital market- the most integral parts of the financial market in a bear economy. When markets are down prospective investors purchase bonds at a considerably low price and re-sell them when the market improves.
India’s debt capital market
India’s debt capital market is characterised by trading of fixed income instruments like securities issued by the central or state governments, Municipal corporations, banks or other financial institutions. Bond or debt is basically a loan on which interest has to be borne by the issuer of the bond. RBI and SBI regulate the debt market in India.
Some of the debt instruments offered by the government and non government entities are
- MIBOR linked bonds – MIBOR (Mumbai Interbank offered rate) bonds are remodelled on LIBOR(London Interbank offered rate) bonds.
- Commercial papers – Promissory notes issued by corporate houses for short term purposes only.
- Treasury bills – Reserve Bank of India is responsible for the issuance of treasury bills.
Risk involved in debt capital market
The debt capital market is not without its fair share of risk-
- Government securities have zero credit risks unlike corporate papers subject to a change in business conditions.
- Interest rate risk is another problem of debt securities. There is always a possibility that interest rates may rise leading to a decline in value of traded debt instruments
- There is also an added risk that one party may fail to comply with the terms of the contract at the time of settlement.
Trend of debt capital market of India
India is now witnessing a surge in the activities in the debt capital market owing to a downfall of players like DHFL.
Laterally priced trades work as a major hindrance to retail and institutional investors. So barring a few major players most business houses prefer to shy away from debt capital markets.
As per the statement issued by Reserve Bank of India, India’s domestic corporate bond market accounts for 16% of the country’s GDP. This is abysmally low when we compare South Korea’s 70%.
Leveraged DCM is a new entrant in India’s financial world dealing with sub-par or risky bonds. These below par bonds and securities have an edge over capital markets. Despite being under-per there is a likelihood of an increase in the resale value of these bonds and securities with the intervention of extraneous and enforcing events.
The debt capital market shows a promising trend although the financial year started with a few glitches. Thanks to the various regulatory announcements, the debt capital market is now showing a positive trend. Aversion to corporate bonds and winding up of debt schemes by mutual fund houses undermine the debt capital market.
However with the easing of the lock down restrictions, introduction of regulatory measures by the Reserve Bank of India like keeping interest rates soft has improved the situation. This has been marked by the new issuance of bonds during the last few months.
The total number of bonds issued in the fiscal year 2021 roughly amounted to more than 75% of the sale issued in the previous year. Targeted Long Term Repo Operations provided low cost findings to banks. This enables them to buy corporate bonds in the primary and secondary markets. With a rise in collection in September and October, 2021 by various lenders we hope to see an increase in disbursement volumes.
The issuance of a circular by Securities and Exchange Board of India for the creation of security on the basis of corporate bonds, net flows have improved in debt mutual funds. This is a good indication as mutual funds are active participants in the Bond markets. They account for 17-18% of the bond volume.
SEBI has proposed to purchase illiquid investment grade bonds thereby hoping to improve liquidity in corporate bonds.
The increase in size and sophistication of debt capital markets is a positive reflection. Mortgage backed securities, new entrance from the insurance industry and the introduction of new products will have a positive impact on the primary market. Secondary markets will too receive an overhaul with the introduction of new policies like dematerialization and early addressability of stamp duty issues.