Chapter 3. Rationale for a Primary Dealer System

Marco Arnone, and Piero Ugolini
Published Date:
February 2005
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The main purposes of a primary dealer system include strengthening the primary market by (1) helping to build a stable, dependable source of demand for securities; (2) providing liquidity in the secondary market; (3) devoting capital resources to underwriting (as a proprietary buyer) to absorb an occasional shortfall of liquidity; (4) building distribution channels (to act as intermediaries); and (5) providing market information, including prices, volumes, and spreads between bids and offers. These objectives, in turn, serve the overall goals of (1) lowering the cost and associated risk of servicing the public debt; (2) developing financial markets; (3) enabling the central bank to use indirect instruments of monetary policy; and (4) encouraging saving by providing a relatively risk-free investment with attractive returns.

Development of financial markets involves a broader set of policies than just establishing a primary dealer system. In particular, some countries may have set up PD systems without necessary supporting policies, including a commitment to a market-clearing outcome. Based on empirical observation, establishment of a PD system can be an efficient way to develop and execute a coordinated approach to market development and thereby accelerate the development of market structure. Practical experience shows that primary dealer systems are in many cases a very helpful and efficient way to build up a market as well as maintain the functioning of the market in later stages. Other ways to set up markets, however, do exist,1 and, in the choice of different setups, country specificity and historical (path-dependence) considerations might well play a role, along with consideration of theoretical approaches.

Also, setting up a system of primary dealers could be interpreted as a response to a market failure, if the government perceives that the existing market structure is not performing efficiently or if the market does not yet exist or is very thin. This happens typically in many developing countries, where the rationale for primary dealers may rest not only on efficiency arguments but also on developmental reasons, as argued below. Additionally, the creation of a PD system can be seen as a commitment to sound debt management practices. By selecting a specialized set of institutions the authorities might be signaling to the financial community and the public at large their commitment to a liberalized market and a sustainable public debt strategy. Therefore, defining such a group of qualified dealers might increase investors’ confidence in government securities as an investment.


See International Monetary Fund and World Bank (2001b), Chapters 5 and 7.

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