Primary Dealer

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. For example, a primary dealer may underwrite new government debt and act as a market maker for the U.S. Federal Reserve. Primary government securities dealers must meet specific liquidity and quality requirements. They also provide a valuable flow of information to central banks about the state of worldwide markets.

Understanding U.S. Primary Dealers

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 less 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 requirements for broker-dealers that are not affiliated with a bank is $50 million. Banks acting as primary dealers need to have $1 billion of Tier 1 capital (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).

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 J.P. Morgan, Barclays Capital, Wells Fargo, and Citigroup. TD Securities, Morgan Stanley, Cantor Fitzgerald, and Goldman Sachs are also primary dealers.

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.