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Informist, Tuesday, Oct. 1, 2024

 

--MIBOR panel: Banks can look at pricing small loans based on mkt benchmarks 
--MIBOR panel suggests FBIL make new benchmark based on secured money mkt 
--Committee report suggests computing MIBOR using deals from first 3 hours 
--RBI: Invite comments on MIBOR committee report by Nov 15 
--RBI releases report of the committee on MIBOR benchmark

 

NEW DELHI – The committee on the MIBOR benchmark has recommended that Financial Benchmarks India Ltd. construct a new overnight market benchmark based on secured money market rates. It has proposed the new benchmark be called the Secured Overnight Rupee Rate.

 

The overnight Mumbai Interbank Offer Rate is the current benchmark for money market rates, which is also computed by FBIL. The weighted average call rate is the operating target for the Reserve Bank of India's monetary policy. However, the committee said that 98% of overnight money market volume is through triparty repo and market repo in government securities, both markets that include both banks and non-banks. 

 

"Benchmarks based on these markets are also likely to be more robust and less susceptible and hence best suited as benchmarks for interest rate derivatives used for the purpose of hedging," the report said. "At the same time, the Committee also recognised that a benchmark based on the call money rates which is the operating target for monetary policy is likely to be the preferred benchmark for derivatives used to take a view on monetary policy actions."

 

The committee said that it was satisfied with the current computational methodology for MIBOR. A key recommendation was to include transactions based on the first three hours of trade, rather than only one hour, both for MIBOR and the newly proposed secured overnight funding rate. This rate should comprise basket repo transactions and the triparty repo rate, the committee recommended.

 

The RBI uploaded the committee's report on its website Tuesday. The report is dated April 2024. The panel was headed by former RBI executive director Ramanathan Subramanian. The central bank has invited comments on the report by Nov. 15.

 

In addition to the development of the Secured Overnight Rupee Rate, the committee also recommended the development of an interest rate derivative based on the rate. Along with the computation and publication of the rate by FBIL, the committee recommended that the Fixed Income Money Market and Derivatives Association of India draw up operational guidelines and market conventions for transactions in a derivative based on the Secured Overnight Rupee Rate. The association could help in popularising it, while the Clearing Corp. of India Ltd. develops trading and clearing infrastructure, according to the recommendations.

 

A transition to the new derivative from the currently prevalent overnight indexed swap rates based on the MIBOR would take time, and should not be encouraged until there is enough liquidity in the new instruments. In the meantime, market participants can use both derivative instruments, the committee said.

 

In other specific recommendations for derivatives markets, the committee said non-residents should be allowed access to onshore interest rate derivatives markets beyond MIBOR OIS for purposes other than hedging, gradually and with appropriate controls. Their activity in the MIBOR OIS market has deepened the market with liquidity and aided price discovery, the committee said. Sectoral regulations for various financial sector entities such as non-banking financial companies, mutual funds and insurers should also be reviewed to allow more flexibility to manage interest rate risks, the report said.

 

The committee also suggested a shift to lending based on market-determined rates, rather than those linked to the policy repo rate, which will allow banks to better hedge their risks. External benchmark-linked loans made up 56.2% of outstanding floating rate loans as of December, up from 44% in March 2022. Loans are typically priced at money market rates instead of the repo rate, and there are few or no international rate derivatives linked directly to the central bank policy rate.

 

"The Committee noted that the pricing of loans based on policy rates makes it challenging for borrowers to hedge their interest rate risks especially when interbank rates diverge from the policy rate," the report said. "It also exposes banks seeking to hedge their own interest rate risks to basis risks (given the basis spreads between policy rates and benchmarks on which IRDs are available)," referring to interest rate derivatives.

 

Initially, banks could explore pricing small-ticket advances to term benchmarks such as one based on treasury bill rates, to allow easier hedging in derivative markets. Concerted efforts to develop a basis swap market also need to be made to better provide hedging opportunities, the committee said.

 

A basis rate swap consists of two underlying variable interest rates, unlike the OIS which has a fixed and floating leg. The goal of a basis rate swap is for a company to limit the interest rate risk it faces as a result of having different lending and borrowing rates.

 

In addition, interest rate products linked to term-rates instead of overnight, unsecured rates such as the MIBOR must be developed, and liquidity encouraged in such products, the committee said. It recommended that FIMMDA set up a working group to develop a market for basis swaps and finalise market conventions for both those and term-repo products.

 

Its final recommendations were to Clearing Corp. of India, which operates the Anonymous System for Trading in Rupee OTC Interest Rate Derivatives, that trades and clears the bulk of MIBOR OIS trades in the market. It acts as a central counterparty across many segments of money markets, including call and term repo market. The clearing house could look at introduction of electronic trading for a larger bouquet of interest rate derivative products, such as Treasury-bill linked swaps and basis swaps, the committee said. Clearing Corp. of India could also introduce central clearing for such products, according to the recommendations.

 

"The Committee noted the significant role played by market infrastructure (e.g., trade reporting and dissemination, electronic trading and central clearing) in the development of the domestic IRD market by ensuring transparency, a level-playing field for smaller market participants and ensuring efficiency," the report said. The MIBOR committee also recommended the publication of anonymised trade information on interest rate derivative products could be reviewed or enhanced.  End

 

Reported by Aaryan Khanna

Edited by Akul Nishant Akhoury and Ashish Shirke

 

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