Let’s understand with an example.
Say there’s a government bond of 2-year maturity and a 6% coupon rate. The face value of the bond is ₹100. The coupons are payable half-yearly, which means that a ₹3 coupon matures every 6 months. So the maturity table looks like this:
Through the process of Stripping, a bank or an individual can split all these coupon payments of varying maturity into different STRIPs itself and sell them. So from one Government bond of 2 years maturity, we can get 5 STRIPs, four coupon securities (representing the coupon payments), maturing on respective dates, and finally one representing the principal amount which will be redeemed on the ascribed date.
In simple words, there will be 5 STRIPs created, One of 6-month maturity, one of 12-month maturity, one of 18-month maturity, and 2 of 24-month maturity. These STRIPs will be issued at a certain rate of discount and will act as stand-alone security resembling the zero-coupon bond characteristics.
The opposite of stripping or reverse stripping is when the coupon strips and principal strips are reassembled into the original government security. It is known as reconstruction.
According to the RBI, all fixed coupon securities issued by the Government of India, irrespective of the year of maturity, are eligible for Stripping/Reconstitution given that they are tradable or transferable and qualify for SLR.
STRIPS was introduced by the RBI to ensure the availability of sovereign zero-coupon bonds, with an aim to develop a market-determined zero yield curve. It is also considered to provide institutional investors with an additional instrument for their asset-liability management. STRIPS are discounted instruments with no periodic interest payments and hence, have zero reinvestment risk. This makes it attractive to retail and non-institutional investors as well.
All primary dealers and Banks are eligible for the process of stripping and reconstruction. Market participants, having an SGL account with RBI can place requests directly for stripping/reconstitution. In fact, even individuals and Gilt Account Holders (GAH) can request through their custodians to strip such securities held by them.
All requests of individuals and PDs for stripping and reconstruction have to be registered and processed through the e-Kuber platform. Requests for stripping can be submitted only between 9 am and 2 pm on a business/ working day, by the participants who wish to do so.
The minimum amount or the face value of securities that need to be submitted for Stripping or Reconstitution should be of ₹1 crore and multiples thereof.
STRIPs are eligible securities for market repo as well as repo under LAF of RBI but with appropriate haircut. Even though STRIPS are tradeable on the NDS-OM platform since 2013, majority of them happen through OTC trades that have to be reported on NDS for clearing and settlement of the same. The short sale of STRIPS is not permitted.
A Bank can strip security in the HFT category. However, if it wishes to strip security which is under the HTM category, it first needs to transfer the same into HFT.
We have seen active trading in principal STRIPs in the repo segment in FY19 which witnessed 217 trades with a face value of 71,080 crore. Trading in STRIPs is gradually picking up following these changes, although the volumes are still not substantial.
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