Advanced Analysis of the Indian Money Market: NISM Series-XXII Part Two

This second part of the study guide for Chapter 8 explores the prevailing trends in the Indian money market, the critical role of the call money segment, key interest rate benchmarks, and the complex mechanics of repo transactions.

8.3 Trends in the Indian Money Market

The Indian overnight money market is primarily dominated by three instruments: Call Money, Market Repo in government bonds, and Tri-party Repo (TREP).

Market Volume Dynamics

• Dominance of TREP: Although the RBI identifies the unsecured call money market as the primary indicator for systemic liquidity, it actually accounts for less than 10% of daily traded volumes. The TREP segment dominates the market in terms of volume.
• Participant Roles:
  • Borrowers: Primarily Primary Dealers (PDs) and various banks (Public, Private, and Foreign).
  • Lenders: Dominated by Mutual Funds, Co-operative Banks, Insurance Companies, and Financial Institutions.

8.4 Importance of the Call Money Market

The call money market is the second most liquid asset for lenders after cash. Its primary function is to allow banks to manage their day-end demand and supply of overnight funds and meet mandatory Cash Reserve Ratio (CRR) requirements.

Policy Significance and the Operating Target

• Operating Target: The RBI uses the call rate as the operating target of its monetary policy. Changes in policy repo rates are immediately reflected in the call rate.
• Liquidity Reflection:
  • During liquidity shortages, call rates stay near the LAF repo rate.
  • During liquidity surpluses, rates move closer to the LAF reverse repo rate.
• Interest Rate Corridor: The Marginal Standing Facility (MSF), introduced in 2011, provides an informal ceiling for call rates, limiting extreme fluctuations.

Reserve Requirement Rules

• CRR/SLR Inclusion: Borrowings in the call money market create a liability and are included in a bank's Net Demand and Time Liabilities (NDTL) for CRR and SLR computations.
• Term Money Exemptions: To develop the term money market, the RBI allows banks an exemption from reserve requirements if the borrowing is for more than 15 days and less than 1 year.
• Repo Exemption: Unlike call money, borrowings under Repo and TREP do not attract reserve requirements because they are structured as buy and sell transactions.

8.5 Important Rates in the Indian Inter-Bank Call Market

8.5.1 MIBOR (Mumbai Interbank Outright Rate)

• Administration: Administered by Financial Benchmarks India Pvt. Ltd (FBIL), with CCIL acting as the calculation agent.
• Calculation: It is a volume-weighted average rate based on actual trades on the NDS-CALL platform during the first hour of trading.
• Exclusions: Trades involving Co-operative Banks are excluded from the MIBOR calculation.

8.5.2 WACR (Weighted Average Overnight Call Money Rate)

• Definition: The WACR is the weighted average rate for all trades executed during the entire day in the call market.
• Significance: It is the official operating target of the RBI’s monetary policy.

8.5.3 Economic Utility of the Repo Market

The repo market is an essential tool for traders to fund positions and express views on interest rate movements.

1. Funding Short Sales: RBI allows short sales up to 90 days. To deliver securities against a short sale, an entity must borrow the security from the repo market.
2. Transaction Path:
   • A trader expecting a price fall sells a security in the outright market.
   • They then borrow that security in the repo market to make the delivery.
   • Positions are rolled over daily until the trader reverses the position by buying back the security in the outright market and selling it in the repo market.

8.5.4 Mechanics of a Repo Transaction

In India, repos are structured as "Buy and Sell Back" transactions rather than traditional loans.

Step-by-Step Calculation Example

Assume Bank A does a Repo for Rs 500 Crore Face Value of a 5.77% GS 2030 bond for 15 days at a borrowing rate of 3.65%.

First Leg (Ready Leg)

• Price: Based on the current market yield (e.g., 5.95%).
• Accrued Interest: Calculated using the bond market convention (30/360E).
• Total Consideration: Face Value * (Clean Price + Accrued Interest) / 100.
• Outcome: Bank A delivers the security and receives the total consideration amount.

Second Leg (Forward Leg)

• Repo Interest: Calculated on the first leg consideration using the money market convention (Actual/365).
  • Formula: Repo Interest = First Leg Consideration * Repo Rate * (Repo Days / 365).
• Second Leg Consideration: First Leg Consideration + Repo Interest.
• Implied Price: The second leg uses an implied clean price derived from the total consideration minus the new accrued interest (for the increased broken period).

Key Takeaways for Exam Preparation

• Market Share: TREP is the most significant segment by volume, even though Call Money is the policy benchmark.
• Policy Correlation: Call rates typically fluctuate between the Repo rate (ceiling/shortage) and the Reverse Repo rate (floor/surplus).
• Reserve Arbitrage: Repo and TREP are more cost-effective for banks because they are exempt from CRR/SLR requirements, unlike overnight call money.
• Benchmark Ownership: FBIL administers MIBOR, but CCIL performs the actual calculations.
• Day Count Conventions: Repos involve two conventions: 30/360E for the underlying bond valuation and Actual/365 for the interest on the borrowed funds.

Important Terms to Remember

• WACR: Weighted Average Call Rate; the RBI's main operating target.
• MIBOR: Mumbai Interbank Outright Rate; a key benchmark for derivative pricing.
• LAF: Liquidity Adjustment Facility; the window through which RBI manages daily liquidity.
• When-Issued Market: A market for trading securities that have been announced for auction but not yet issued; aids price discovery.
• Green-Shoe Option: The right for the Government to retain additional subscription amounts in an auction beyond the notified amount.

End of Chapter 8 Notes.