Rupee Interest Rate Swaps

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Rupee Interest Rate Swaps

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Overview

• Definitions Benchmarks
• Overnight Indexed Swaps
• Uses Opportunities
• Linkages between markets
• Interest Rate- market views

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IRS- Definition

• Exchange of cash flows (Risks)
• Notional Principal
• Prescribed dates
• Prescribed computation method
• FIXED and FLOATING rates of interest.
• Floating based on a market benchmark.

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IRS- Floating Benchmarks

• Independent Transparent
• Dependable (Past Future)
• Examples
• Overnight MIBOR (Mumbai Inter-Bank Offer Rate)
• Commercial Paper Rates
• Prime Lending Rates
• T-Bill Yields (14 , 91, 182 and 365 days )
• Forex Swap Rates (Premia)

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IRS- Floating Benchmarks
Daily MIBOR linked IRS OIS
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Overnight Indexed Swap (OIS)

• Floating leg based on MIBOR
• Daily overnight rate reference
• Compounded daily/ accrued over holidays
• NSE/ Reuters (26-32 banks average)
• Other market conventions
• Pre-defined notional principal.
• Normal FRA / IRS terminology
• Pay/ buy an OIS pay fixed receive floating
• Receive/ sell an OIS receive fixed pay floating

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Overnight Indexed Swap (OIS)
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OIS - Mechanics
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OIS - Mechanics
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OIS - Mechanics
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IRS- RBI Guidelines

• FRA/ IRS allowed for hedging rupee balance sheet
  exposures.
• Banks to exercise due diligence
• Certificates that transaction for hedging balance
  sheet exposures (w.r.t. size and tenor)

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IRS- Benefits

• Essentially divorces liquidity management from
  interest rate risk management.
• Simple to use
• Minimal credit risk
• No ballooning of balance sheet

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IRS- Opportunities

• Better interest rate risk management
• Diversification of risk
• Implement interest rate views
• Access to cheaper funding
• Comparative Advantages
• Good Cash/ Liquidity Management Tool
• Monthly collections vs quarterly interest payments

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IRS- Structures

• Hedge increases- go fixed
• Hardening rates Fix future CP issue/ rollover
  costs
• Convert floating WCDL into fixed rate
• Reduce costs- go floating
• Softening rates Raise term funds but pay MIBOR
• Receive fixed against existing fixed rate loans

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Example I - Comparative Advantage

• Funding at lower MIBOR spreads than before
• AAA issues 1yr fixed at 11.10
• OIS AAA receives Fixed 10.00
• AAA pays MIBOR
• Net impact is 1 year funds _at_ MIBOR 110BPs

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Example II - Lending at Call

• Placement of deposits at call-linked rates
• ABC buys 180 day T-Bills 9.8
• OIS ABC pays fixed 9.5
• ABC receives MIBOR
• Net impact is 180 day return _at_ MIBOR 30BPs
• Has effectively lent in the call market

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Example III - Hedging future CP Rates

• Locking in future funding costs
• ABC has Rs.100mio CP maturing in 3 months
• FRA (or IRS) for 3v6 at 10.8
• Unwind FRA at time of rollover
• Net impact is CP funding rate _at_ 10.8
• Profit/ loss on unwind will offset rate received

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IRS- Current scenario

• Flurry of OIS deals on Day 1
• Corporates - Main receivers of fixed rates
• Limited inter-bank deals
• ISDA documentation
• Not represented fully by all foreign banks PDs
• Absence of nationalised banks

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IRS- Future Scenario

• More volumes
• Longer tenors
• Other new benchmarks
• MIBOR, but not overnight based
• Other index based
• Banks end up being Payers of fixed rates
• Keen interest by nationalised banks

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IRS- Issues

• Illiquidity in the secondary corporate bonds
• T Bill reference rate yet to evolve despite
  existence of a T Bill auction calendar
• Expected time for development of a term money
  market
• Accounting/tax for IRS/FRAs (Hedge vs MTM)
• Basis risk

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Linkages between markets

• Call Money vs Forward Premium
• Arbitrage potential
• Immediate response across curve
• IRS vs CCY swaps (Premia) vs T-Bills
• Accessible by the main banks
• Different considerations
• Other markets more liquid/ less bid-offer

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Linkages between markets
Call Money rate was 10.12 (as on Aug 1699)
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Linkage between markets

• IRS Call - 62 bps
• Reflecting 6 month expectations
• T Bill IRS 20bps
• Reflecting funding risk
• Swap Tbill 110bps
• Swap Libor Premium
• Reflecting short term reaction
• IRS cannot be more than Swap

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Continuing discontinuities

• High bid-offer spreads in IRS
• Lack of efficiency
• Fewer aggressive banks/ Docs/ Credit issues
• Logistical/ internal limitations
• Cash vs. IRS
• Liquidity fears (50bps)
• LAF- guarantees liquidity, start made (like FED)

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Continuing discontinuities

• TBIlls vs Fwds
• FCNR USD funds with few banks
• surplus INR other banks
• Switching difficult from both sides
• Difficult to short GOI securities- 1way
• 15 rule for longer tenors
• Short end is relatively integrated

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Interest Rates - so far

• Shocks in Jan/ Aug98
• Interest rates lower across the board in 1999
• Successfully survived a major event risk- Kargil
• Historically low inflation
• Increasing liquidity, longer tenors in bonds
• RBI approach
• Openness - e.g. Feedback on Policy
• IRS- hedging mechanism
• Public statements on objectives
• Corridor of interest rates.

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Interest Rate- Trends
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Interest rates - Sovereign

• Surplus liquidity, low inflation
• Banks
• Evaporating fears of liquidity crisis
• shocks still there (12/08)
• Surplus SLR due to lack of alternatives
• Government
• FY99-00 Govt. net borrowing target (78 done)
• Long tenor based rally - high duration
• Oct. Credit policy, higher fiscal needs- Kashmir

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Interest rates- Corporate

• Limited Supply, growing demand
• Mutual Funds
• Tax anomaly driving the industry
• Flush with liquidity - funds seek yields
• Compression in Corporate spread over GOI
• Compression to shift to longer tenor/ Tier II
  names
• Trend to reverse (Q300) after a few shocks
• Spike in GOI yields/ Ill-liquidity/ Credit
  deterioration

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Interest rates - prognosis

• Likely to trend lower
• Inflation yet to hit bottom(Nov)
• Higher Real yields
• No signs of credit pickup
• Expansionary Credit policy
• Bank rate/ Repo/ CRR cut Deposit rates/ PLR
  sticky
• Accommodate govt. borrowing targets
• No / INR shocks/ Political uncertainties

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Rupee Interest Rate Derivatives and Citibank

• Trading expertise. Experienced team
• Ability to offer low bid-offer quotes
• Risk management systems in place
• Exposure to IRS products in Emerging Markets
• Huge corporate reach- Can match requirements

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Disclaimer

• Although the information contained herein is
  believed to be reliable, Citibank makes no
  representation as to the accuracy or completeness
  of any information contained herein or otherwise
  provided by Citibank.
• The ultimate decision to proceed with any
  transaction rests solely with the customer.
  Citibank N.A. is not acting as your advisor.
  Therefore, prior to entering into any proposed
  transaction, you should determine the economic
  risks and merits, as well as the legal, tax and
  accounting characterizations and consequences of
  the transaction, and that you are able to assume
  these RISKS.
• The contents of this presentation are proprietary
  in nature, and may not disseminated in whole or
  in part without Citibank's written consent.