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BW Businessworld

Money Markets To Get Busier

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Stability, liquidity and depth. That's what the Reserve Bank of India's (RBI) annual monetary policy that RBI governor Duvvuri Subbarao presented on 3 May is expected to bring to the money markets. We aren't talking about the policy rate changes here, but the regulatory changes that are likely to influence the overnight money and short-term money markets.

Unlike stockmarkets, the money markets in India haven't been as liquid or as broad and deep. Which is in contrast to developed markets where debt markets are many times the size of equity markets. The measures announced come in three little buckets: little, because the changes, in the tradition of caution practised by the central bank, are seen as some baby steps towards creating a vibrant money market.

                                NEW NORMS

Marginal Standing Facility (MSF) A new borrowing window for banks in times of extreme cash crunch. Its rate will be 100 basis points above repo.

Credit Default Swaps (CDSs) These credit derivatives will help broaden the corporate bond market. Guidelines to be issued soon.

# 3-month span for short selling in G Sec Market participants can now short (sell) their government securities from five days (earlier) to a maximum of three months

First, the marginal standing facility (MSF) that allows banks to borrow up to 1 per cent of their deposits from the RBI, albeit at 1 per cent higher than the repo rate (at which banks borrow from the RBI). Call or overnight money markets — in which banks borrow from each other and from mutual funds and a few institutional investors — are mostly uncollateralised; the MSF changes a part of that into collateral-based lending.

The collateral in this case will be the same as that used in repos with the RBI, government securities. "It should help reduce volatility of overnight rates over the long run," says Vivek Rajpal, interest rates strategist with Nomura India in Mumbai. Call money rates should now be close to the repo rate of 7.25 per cent, but can occasionally get very volatile; in recent weeks, it has gone up to 12 per cent. "The MSF will serve as a hurdle rate for overnight borrowing," says Rajat Monga, Yes Bank's head of financial markets.

Second, and more interesting for many treasury dealers, is the announcement that guidelines for credit default swaps (CDS) in corporate bonds will be released soon. It was earlier announced in October 2009. But given that the CDS market was at the core of the meltdown of the mortgage market in the US, the central bank's caution is understandable.

But the reaction was mixed. "CDS will enable lenders to diversify their credit portfolio beyond their own set of customers, leading ultimately to a lower risk," says Phani Shankar, head, financial markets, at ING Vysya Bank. "It will broaden the market bringing in a larger pool of investors increasing the liquidity and depth."

But credit derivatives have not taken off as well as hoped. Take the introduction of interest rate futures (IRFs), where momentum has been largely absent. "This is still too early; early avatars of IRFs have not done too well," says Manish Sarraf, treasury head at Dhanlaxmi Bank. "And since CDS are on specific entities, liquidity may be a challenge."

Third, the central bank extended the ability of banks to short-sell government securities (another way of taking a call on how interest rates will move) from five days to three months. This allows traders and dealers to take the longer view, but most like Monga and Sarraf believe it will be a while before this becomes a more widely used instrument.

The changes add breadth to the menu of instruments, but depth is still a problem. So don't be surprised if they don't go diving in right away.

(This story was published in Businessworld Issue Dated 23-05-2011).