Mumbai: A new overnight transaction system introduced by Clearing Corp. of India Ltd (CCIL), which oversees the settlement of trades in the bond, currency and money markets, has changed the way financial institutions lend and borrow from each other on a daily basis.
Under this system, called Clearcorp Repo Order Matching System, or Croms, parties trade anonymously on an online order-matching platform.
Instead of negotiating over individual bonds, as was done earlier, financial institutions, typically banks, use a mix of the most liquid government securities as collateral. This transaction is guaranteed by CCIL.
Banks had until now been using individual government securities, considered the safest, as collateral for bilateral financial transactions; this is also known as a repo transaction.
Using a combination of highly traded securities as collateral is a global practice, informally known as a basket repo.
Ravi Rajan, executive vice-president of CCIL, said the baskets are reviewed every month and altered depending upon the liquidity profile of the securities.
“In a basket repo, the system delivers you one, some or all the securities in a way that maximum value is derived with minimum securities. From the point of executing the deal, CCIL works as the guarantor,” he said.
Banks need overnight money to tide over their temporary asset-liability mismatches. They can access overnight money through various sources, including pledging securities with the Reserve Bank of India at its liquidity-adjustment facility window. Banks can also make use of the call money market where no collateral is needed, but interest rates are higher.
However, since RBI offers its repo facility only once a day, in the afternoon, financial institutions are compelled to borrow from each other.
The mutually beneficial arrangement allows those in need to borrow outside of the RBI window, and those with extra funds to park the surplus with the call money market or the over-the-counter (OTC) repo market.
The repo market in the country is largely an informal OTC market, or a market where no exchange is involved. In an OTC repo trade, both parties negotiate the interest rate and the kinds of securities to be held as collateral. Interest rates for such overnight lending are typically decided over the phone and may vary depending on the size of the lender, and the maturity and liquidity profile of the securities involved.
Under Croms, introduced in mid-January, a lender can still decide on which security it wants as collateral for extending the credit under its special repo facility. However, under the new facility, baskets of different maturities are created by CCIL with about three-five kinds of most liquid, or heavily traded, government securities.
The price of the basket is determined by CCIL taking into consideration market prices, mark-to-market prices or prices quoted by the Fixed Income Money Market and Derivatives Association of India. Mark-to-market is an accounting practice that values an investment at current market price.
The interest rate, however, is decided by the market participants, who can see the securities in the basket.
“The baskets comprise of only most liquid securities and trades are anonymous. Thus the parties are free from any haggling over the securities under which borrowing or lending is being undertaken and small players are protected from the tougher terms offered by the larger players,” said Rajan. “This is establishing a completely level playing field.”
Typically, the repo rate is always lower than the call money rate because of the availability of collateral in the transaction.
Rajesh Salunkhe, a senior manager with CCIL, expects repo rates to come down as the Croms transaction is completely transparent and is backed by a guarantor.
Rajan claimed that 55% of the repo trade has shifted to the Croms network, with about 70% of those transactions happening in the basket repo segment.
The total repo market is estimated to have a daily volume of at least Rs35,000 crore.
Bank treasurers have welcomed the new transaction system and see it as a potent tool to manage their asset-liability mismatches.
“Suppose a bank doesn’t want to have longer tenure security at the end of the month, as they might have to provide higher mark-to-market losses if the security is not performing, they can just trade on the short-term treasury bills baskets and vice versa,” said Harihar Krishnamurthy, head of treasury at FirstRand Bank, adding that it is an improvement over the previous system. FirstRand Bank is a South African entity.