India’s Bond Market Puzzle: The Missing Market Makers

India’s bond market struggles for a straightforward reason: the participants best placed to provide liquidity do not trade enough. Without active trading, credible yield benchmarks fail to develop, liquidity remains thin, and the corporate bond market never truly takes shape.

Three structural gaps lie at the heart of the problem. First, the absence of a large investor category with a strong incentive to trade. Second, weak benchmark yields. Third, the limited participation of investors and traders in non-government bonds. Until these are addressed, the market will continue to lack depth.

Anchor Investors
Over 40% of India’s outstanding central government securities are held by provident funds and insurance companies. These institutions are natural long-term investors. Their liabilities require stability rather than trading, which means they rarely buy and sell bonds actively.

Banks are structurally different. They already hold roughly 36% of the outstanding government debt stock and possess the risk-management systems, market access and regulatory framework necessary to support active trading. In modern universal banking models, trading is an important business line alongside lending.

International comparisons underline the gap. Indian banks allocate only about 25% of their debt securities portfolios to trading (HFT) and trading-like (AFS) books that are subject to mark-to-market treatment. Among global peers, the comparable share is typically 60–75%.

Foreign banks also lend far more through the investment route by purchasing tradable debt instruments. Consequently, their investment portfolios account for a larger share of their balance sheets than those of Indian banks.

Another difference lies in the structure of held-to-maturity portfolios. In advanced markets, these portfolios contain larger shares of non-government securities. Government bonds are not typically locked away in HTM books because they are liquid and therefore better suited for trading.

Indian banks face a classic chicken-and-egg problem. Liquidity is too limited to encourage trading, yet without trading the market never becomes liquid. A practical starting point would be for banks to increase activity in government bonds and allow a portion of their holdings to move out of the banking book.

The scale of the difference is striking. International banks often derive more than 40% of their income from debt securities and trading activities. To support this, they allocate up to 45% of their capital to such businesses—between 7 and 10 times the proportion deployed by Indian banks.

Unless trading becomes a central part of banking activity, the bond market will struggle to deepen.

Benchmark Question
A functioning government securities market is the foundation of any broader bond ecosystem. Active trading creates reliable benchmark yields, and those benchmarks anchor pricing across the entire fixed-income market.

In India, market participants often attribute low trading volumes to the lack of liquidity and the absence of strong benchmark bonds. Some have suggested reducing the number of tradable securities so that liquidity concentrates in fewer instruments. Yet this may not be the core issue.

Many of the world’s most liquid government bond markets have far more issuances than India, which currently has roughly a hundred. Liquidity in those markets emerges not from fewer bonds, but from continuous trading and price discovery.

In India, liquidity clusters around a few benchmark maturities—typically the 1-year, 5-year and 10-year segments. Once a bond drifts away from those benchmark ranges as time passes, trading activity declines sharply.

The contrast with mature markets is instructive. In the United States, a bond with more than 10 years remaining maturity may serve as the 10-year benchmark for over a year. Even after it ceases to be the benchmark, trading does not collapse.

Prices continue to be discovered by interpolating yields between neighbouring benchmark maturities—for example between the 10-year and the 7-year bonds. As a result, bonds remain tradable even after losing benchmark status.

India broadly follows similar benchmark conventions, but the market’s definition of liquidity remains far narrower.

Corporate Debt
The weakness of government bond trading inevitably affects the market for non-government securities: debt issued by corporates, NBFCs, banks and municipalities.

For a corporate bond market to develop meaningfully, banks must increasingly fund investment-grade companies through the purchase of tradable debt rather than relying overwhelmingly on loans. Only then will risk-based differentiation between issuers emerge, laying the groundwork for a true credit market.

This shift should not be seen as an act of public service. It aligns with the commercial interests of banks themselves. A deeper bond market broadens financing channels, improves capital efficiency and opens new revenue streams.

The obstacles are already in plain sight. The real question is what it will take for Indian banks, and the market around them, to begin trading in earnest.

(This is the first part of a two-part series on India’s bond market challenges. The second part will focus on possible solutions.)