The month of March has seen some of the highest volatility seen in the inter bank overnight rates in India’s money markets. NSE Overnight MIBOR, the most widely used benchmark saw, both, its yearly low – 5.21% on March 5 - and its yearly high – 68.27% on March 30 – during the month.
Part of the problem lies in structural issues that policymakers do not seem inclined to address. A couple of these were discussed by me in this previous post.
The future, for overnight money markets, looks even more uncertain. Effective April 1, 2007 the following limits apply to inter bank liabilities (borrowing by one bank from another); (The relevant notification is here)
- 200% of net owned funds (as on March 31 of the previous financial year) if risk adjusted capital adequacy is 11.25% or below
- 300% of net owned funds (as on March 31 of the previous financial year) if risk adjusted capital adequacy is above 11.25%.
- These limits apply for overall borrowings from another bank and overnight call money is a sub limit of the same.
While the Reserve Bank of India (RBI) has given some leeway for banks who may face immediate difficulties in implementing this, as a policy this effectively forces banks to borrow more from non banks.
Now, except for retail deposits and issuances of CDs, banks can only borrow from non banks through the collateralized borrowing route. With a relative scarcity of securities eligible for delivery as collateral, banks are left with little choice in bridging large short term mismatches in cash flow and Asset Liability Management (ALM). While good ALM practices would mitigate the problem to some extent, it is not a panacea.
Recent policy moves have also widened the LAF corridor. Instead of moving to a single benchmark policy rate, we now have a wider corridor of rates.
The resulting situation is that we will be witness to significant bouts of volatility in the overnight rate. MIBOR is used as a benchmark to price a large number of transactions, especially in the OTC derivatives market. It is important therefore that it retains credibility in the eyes of marketmen. Recent volatility witnessed in this benchmark does nothing to justify this.
Both NSE and RBI need to take a hard look at this. It may be too early to call for the death of MIBOR as the overnight benchmark, but if bouts of extreme volatility become a norm, market participants will start looking elsewhere for a benchmark to price transactions and / or assets.
It may not be a bad time to start paying closer attention to the CCBOR.