What Is a Primary Dealer?
A primary dealer is a bank or other financial institution that has been approved to trade securities with a national government. In many countries, primary dealers are the only entities who can make a bid for newly-issued government securities. A primary dealer in the U.S. may thus underwrite new government debt and act as a market maker for the U.S. Federal Reserve, commonly referred to as the Fed.
Primary government securities dealers must meet specific liquidity and quality requirements. These are often large investment banks or financial institutions. As such, primary dealers also provide a valuable flow of information to central banks about the state of domestic and global markets.
Note that a primary dealer should not be confused with a prime broker.
- A primary dealer is a bank or other financial institution that has been approved to trade securities with a national government.
- Primary government securities dealers sell the Treasury securities that they buy from the central bank to their clients, creating the initial market.
- A firm must meet specific capital requirements before it can become a primary dealer.
- Some of the best-known primary dealers in the United States include large investment banks like JPMorgan Chase & Co, Barclays Capital, Wells Fargo, and Citigroup.
Understanding Primary Dealers in the U.S.
Primary dealers in the U.S. are a system of banks and broker-dealers authorized by the Federal Reserve System to deal directly in government bonds. This system was established in 1960 by the Federal Reserve Bank of New York (FRBNY) to implement monetary policy on behalf of the Fed.
By purchasing securities in the secondary market through the FRBNY, the government increases cash reserves in the banking system. The increase in reserves raises the money supply in the economy. Conversely, selling securities results in a decrease in cash reserves. Lower reserves mean that fewer funds are available for lending, so the money supply falls. In effect, primary dealers are the Fed’s counterparties in open market operations (OMO).
Primary dealers bid for government contracts competitively and purchase the majority of Treasury bills, bonds, and notes at auction. Primary government securities dealers sell the Treasury securities that they buy from the central bank to their clients, creating the initial market. They are required to submit meaningful bids at new Treasury securities auctions.
In a way, primary dealers can be said to be market makers for Treasuries.
Requirements for U.S. Primary Dealers
A firm must meet specific capital requirements before it can become a primary dealer. The capital requirement for broker-dealers that are not affiliated with a bank is $50 million. Banks acting as primary dealers must have at least $1 billion of Tier 1 capital (i.e., equity capital and disclosed reserves). Prospective primary dealers need to show they made markets consistently in Treasuries for at least a year before their application.
Primary government securities dealers must also maintain at least a 0.25% market share. Broker-dealers applying for a spot in the primary dealer system must register with the Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Authority (FINRA).
Once established, a primary dealer must submit accurate reports of their Treasury dealings to the New York Fed on a weekly basis. In addition, primary dealers are asked to respond to regular Fed surveys measuring market sentiment, economic expectations, and opinions about monetary policy measures. The Fed subsequently releases these statistics and data for use by the financial community and the general public.
A firm must meet specific capital requirements before it can become a primary dealer.
Examples of Primary Dealers
Because of the strict requirements for primary dealers, many of them are famous financial firms. Some of the best-known primary dealers in the United States include JPMorgan Chase & Co, Barclays Capital, Wells Fargo, and Citigroup. TD Securities, Morgan Stanley, Cantor Fitzgerald, and Goldman Sachs are also primary dealers in the U.S.
Primary Dealers During the 2008 Financial Crisis
In response to the subprime mortgage crisis and the collapse of Bear Stearns, the Federal Reserve set up the Primary Dealer Credit Facility (PDCF) in 2008. The PDCF allowed primary dealers to borrow overnight at the Fed's discount window using several forms of collateral, including mortgage-backed securities. Federal Reserve banks are authorized to accept loans and other bank obligations as collateral for advances at the discount window. The PDCF closed on February 1, 2010.
Why Do Economies Need Primary Dealers?
Because most modern economies rely on fractional reserve banking, when primary dealers purchase government debt in the form of Treasury securities, they are able to increase their reserves and expand the money supply by lending it out. This is known as the money multiplier effect.
How Do Primary Dealers Make Money?
Primary dealers buy bonds directly from the government and then resell them to clients and investors at a slight mark-up. This small difference in price is how primary dealers earn a profit.
What Other Countries Use a Primary Dealer System?
In addition to the U.S., several other countries and regions rely on primary dealers to handle the issuance of government debt. In Europe, these countries include Austria, Belgium, Bulgaria, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, The Netherlands, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom.
In other parts of the world, these countries and regions include China, Hong Kong, India, Israel, Japan, Singapore, Thailand, and Canada.
Please note that there may be additional countries and regions that use a primary dealer system that are not part of this list.