What do the inter-bank call money market, Reserve Bank of India’s (RBI) repo or repurchase rate and Clearing Corporation of India Ltd’s (CCIL) tradeable repo market have in common? All are windows for overnight money where banks can borrow funds for a day to tide over their asset-liability mismatches. There is yet another platform for this—the market repo, a bilateral arrangement between two banks.
Overnight money is sold at these four markets at different rates. On 20 March, when the call rate in India touched 60%, its highest since January 1998, the average interest rate at which banks raised overnight money was 20.63 % and the range was between 6.25% and 60%. The rate at which banks accessed money from the central bank that day was 7.5%. The average rate at the tradeable repo market, known as collateralized borrowing and lending obligation (CBLO), was 10.74% and the range, 7.4%-16%. Finally, the average market repo rate on 20 March was 12.66% and the range, 7.4%-15%.
This possibly makes India’s overnight market the most fragmented money market in the world. Seven years ago, in June 2000, when India’s central bank introduced the liquidity adjustment facility (LAF), its objective was to create a corridor for overnight rates and curb excessive volatility in money markets. Under the LAF arrangement, RBI offers liquidity support to commercial banks, when they need money, through its repo window. When there is too much of liquidity in the banking system, RBI sucks out excess cash through its reverse repo window. With the latest hike announced on 30 March, the repo rate is now 7.5%, while the reverse repo rate continues to be 6%. This is the band overnight rates should move in.
In a liquidity surplus situation, reverse repo is the anchor rate for all overnight rates. When liquidity dries up, as is the case now, and RBI pumps in money through its repo window, the repo rate becomes the anchor for one-day money. This essentially means that overnight money across market segments should cost around 7.5% now. Then why did the overnight call rate rise to its nine-year high of 60% on 20 March?
Let’s take a closer look at these markets. Repos or repurchase agreements are contracts for the sale and repurchase of government securities and short-term treasury bills at a future date. In this purchase, the seller repurchases the financial asset at the same price at which it was sold and pays interest on it. The repos can be any duration—between one and 14 days or even longer—but are commonly overnight loans.
In the market repo, the rate—negotiated by counter-parties—is influenced by overall money market conditions.
While the repo is a bilateral deal in which both parties—the borrower and the lender—are obliged to follow the terms of the contract, the CBLO is a tradeable repo in which either side can change the contract by using CCIL’s trading screen. For instance, if a borrower has raised three-day money and does not need it after one day, it can snap the contract. Similarly, if a lender needs the money even before the contract expires, it can pull out of the contract. This is possible because of the tradeable nature of the instrument.
The overnight call money market is a platform where banks can raise loans without collateral. The annualized rate of interest paid on the overnight funds is known as the call rate. This is determined by the demand for funds at any given day, but in a liquidity-scarce situation, RBI’s repo rate is normally the floor for the call rate as banks will first approach RBI to get funds. Similarly, when the system is bursting with liquidity, call rates should be even lower than the RBI reverse repo rate as banks will first rush to RBI to park excess funds at the fixed reverse repo rate.
While call money is a pure inter-bank market, mutual funds and insurance firms are present at the CBLO and market repo platform as lenders. Naturally, their presence boosts the supply of money and pulls down the interest rates in these two segments of the overnight market.
In the case of repos and reverse repos, conducted by RBI as part of its liquidity adjustment facility, rates are fixed by the central bank from time to time. Banks need to provide collateral in the form of government securities and the margin requirement is 5%. This means, to access Rs100 crore of funds, a borrower needs to offer securities worth Rs 105 crore.
So, on 20 March when the banks raised over Rs43,000 crore from RBI’s repo window, they had to furnish over Rs45,000 crore worth of government bonds.
Apart from banks, primary dealers—firms that sell government bonds—are also allowed in the call money market but a complicated settlement system normally keeps them away. Even banks’ access to RBI’s repo window is limited as they cannot raise money without collateral of bonds. With the government bonds in short supply, they cannot raise as much funds as they want from the regulator. Under the regulation, banks are required to invest 25% of their deposits in government bonds and only their excess bond holdings can be used to raise money from the repo window. They do not have too much of excess investment in bonds. A back-of-the envelope calculation puts excess bond holdings by commercial banks at about Rs80,000 crore.
This means on 20 March, had the banking system required an additional Rs35,000 crore money to tide over the liquidity crunch, it would have offered the last bond that it had over and above the regulatory requirement. And even a rupee of excess demand would have led to a default. So, it is the short supply of government bonds that played havoc in March when the system reeled under a severe liquidity crunch. More about this next week.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai Bureau Chief of Mint. Please email comments to firstname.lastname@example.org