Government Securities Lending

A repo lends money against a bond. Government Securities Lending (GSL) lends a bond against another bond.

Here is how the workbook sets it up. The owner of an eligible Government security is the lender. The lender gives that security to a borrower for a fee. The borrower hands over other Government securities as collateral — a safety deposit. The deal runs for a fixed period. At the end, the borrower returns the security it borrowed, and the lender returns the collateral.

Why borrow one particular bond? Because you need that bond, usually to deliver it. The workbook notes that traders who short sell a GOI security must borrow it to make delivery. Short selling means selling a bond you do not yet own. GSL pays the owner a fee on a bond that would otherwise sit idle. It also gives the borrower the exact security it needs.

The framework. RBI issued the Reserve Bank of India (Government Securities Lending) Directions, 2023 in December 2023. They apply to all GSL transactions undertaken in Over-the-Counter markets.

The three legs.

Who may take part.

Why it matters for derivatives. The workbook stresses more than once that short selling in GOI securities is not allowed to all participants, and that RBI allows short sale up to 90 days but the short seller has to borrow the security to deliver. That constraint is exactly what limits strategies such as reverse arbitrage in bond futures, which requires selling the bond in the underlying market. A market for borrowing specific securities widens who can actually deliver.

Illustrative participants, amounts and fee.

A primary dealer eligible to short sell expects yields on Bond X to rise. It sells Rs 100 crore face value of Bond X in the market — and now has to deliver a security it does not own.

A bank eligible for repo holds Rs 300 crore of Bond X that it plans to keep to maturity. Through a GSL transaction:

The PD delivers the borrowed Bond X to its buyer.

Ten days later yields have risen as the PD expected. It buys Rs 100 crore of Bond X back in the market at a lower price.

The bank earned Rs 1,90,000 on a holding it was going to keep anyway, and never lost its claim to Bond X. The PD's profit or loss is the gap between its sale and repurchase prices of Bond X, less the fee. The lending itself did not depend on which way prices moved.

Chapter 1 (Introduction to Interest Rate, Interest Rate Instruments and Fixed Income Markets) sets out GSL in section 1.14.1, immediately after open market operations and G-Sec buybacks, with the full definition and the eligibility of borrowers and lenders. The repo market discussion in section 1.14.3.2 explains why short sellers need to borrow securities, and Chapter 5 (Strategies) notes that short selling restrictions limit reverse arbitrage. Expect definition questions — collateral is other G-Secs, not cash — and eligibility questions.

• The collateral is other Government securities, not cash. Cash against securities is a repo.
• The lender receives a fee, and both securities come back at the end of the specified period.
• Borrowers must be short-sale eligible (Short Sale Directions, 2018); lenders must be repo eligible (Repo Directions, 2018). Do not swap them.
• The Directions are RBI's, issued December 2023, and apply to OTC GSL transactions.
• Short selling of GOI securities is not open to every participant — which is why borrowing a specific bond matters.
• GSL is not an open market operation. OMOs are RBI buying or selling outright to adjust liquidity.