Fixed income securities Lec-2

1. Questions
Role of RBI in the Money Market -
(moderate Money Supply on daily basis =>
excess cash => Deposit with RBI (Reverse Repo
window where Banks will lend to RBI and RBI
will pay Reverse Repo Rate to the Banking
system (policy Repo Rate and according a Fixed
Reverse Repo Rate is given out => Banks have
choice as to whether to lend Money at fixed
Rate to RBI or wait for the Variable Rate
Window to open so that they can lend money
at Variable Rate)
=> shortage of cash in the Market => Banks will
borrow money from RBI and pay the Fixed Rate
Repo => As per the Monetary policy, RBI will
operate an window called Liquidity Adjustment
Facility (LAF) where the Fixed Rate Repo would
be available for Banks to borrow upto 0.25% of
NDTL and borrow at Variable Rate upto 0.75%
of NDTL during Normal RBI Market hours. After
the RBI market hours or after reaching 1% limit
(NDTL), if a Banks needs funding, it will borrow
using MSF (Marginal Standing Facility) window
FISM2 - 22/10/2021
Saturday, October 16, 2021 10:35 AM
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2. of RBI. (For example, on 21-Oct-2021, a Bank
borrowed 370CR from RBI at MSF Rate which is
fixed 25bps above the Policy Repo Rate.
Repo Rate is applicable for normal borrowing
limits which is within 1% of NDTL within the
approved timings of RBI. MSF is a penal Rate
which is fixed 25bps above Repo Rate in case a
Bank needs funding beyond above parameters.
MSF is exact rate of Bank Rate.
Using this LAF window, RBI moderates Money
Supply => either it lends money or it absorbs
liquidity from the Banking system.
RBI also opens special window for providing
liquidity support to the Banking system where
Banks can access the designated pool to on-
lend their customers. (Fed Quantitative Easing)
9082323799 / 9820511897
Why a Central Bank operation (Asset Buying
when there is a crash in the market) helps?
When the Assets are held in the Books of the
Banking system, Banks have to necessarily use a
concept called "Mark to Market" => they have
to value on daily basis and provide for the
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3. to value on daily basis and provide for the
depreciation in value by eating up their own
capital / reserves. Capital is eaten up =>
Business is linked to RWA (Investments are
Assets ) => Less Business a Bank can do when
Capital falls. (Infusion of Capital or
Recapitalizing the Banks). The provision of
providing for losses in the Books is as per the
requirement of Basel Regulations.
But Central Banks around the World are not
categorized as Commercial Banks and hence
they are exempt from Basel Regulations. So
there will be no valuation debit for the assets
(they can hold it in the Book value). The fall
stops there as RBI / Central Bank buys the
assets as it does not intend to sell (all sellers
have been paid out through this target buying
thereby reducing the selling pressure => asset
price stabilizes). If the market has to fund, this
will continue to drop.
As a global practice, Central banks participate in
the Money Market to moderate the Money /
Funds.
RBI Repo or LAF: RBI on one side vs Banks
1)
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4. RBI Repo or LAF: RBI on one side vs Banks
and Primary Dealers (another category of
institutions predominantly owned by Banks
who have given license to Underwrite the
Government Issuances / Borrowings) are on
other side (NO other Institutions are allowed
here). Call Market (Inter-bank market) is also
restricted to Banks and Primary Dealers.
1)
Banks and Institutions vs Banks and
Institutions: All Institutional entities are
allowed to lend or Borrow money from each
other.
Component 1 (non-instrument based
market (Lending & Borrowing based
market): (i) Call (1D) / Notice (2-14D)/
Term (15-364D); => Mostly it is used for
CRR replenishment by Banks (ii) Repo -
Market Repo upto 364 Days => Banks and
Institutions Borrow and Lend against
Government Securities. (iii) Tri-Party Repo
Market (Banks and Institutions vs Banks
and Institutions but the process runs
through a approved Tri-Party (CCIL). (iv)
Corporate Band Repo where the
collaterals are Corporate Bonds.
a.
2)
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5. collaterals are Corporate Bonds.
Component 2: Asset based market =>
(Buying and Selling) => TBs issued by Govt
and bought and sold by participants;
Certificate of Deposits issued by Banks
(upto 1 year)/ FIs (NABARD, EXIM Banks,
SIDBI, IFCI) (upto 2 years; Commercial
Papers - issued by large corporates having
Second Highest Credit Rating for short
term papers and minimum Net worth
condition. All these papers are issued as
Discounted Instruments = They are sold at
a Discount to the Face Value using PV = FV
(100)/(1+R%*n/365). If we have TB for 45
days outstanding maturity and trading at
4.6%, the price would be =100/(1+4.6%*
45/365)= 99.4631
b.
RBI participates only in LAF market to
moderate Money supply and not in any
other part of Money Market.
3)
Monetary Policy interacts with the Money
Market:
Excess Funds in the system: Banks will be
putting their money in RBI (Bankers' Bank)
and RBI will pay the Reverse Repo Rate to
a.
4)
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6. and RBI will pay the Reverse Repo Rate to
fund such lending by Banks. In case of
Excess funds in the market, Banks have a
choice to either lend them to other Banks
or to RBI. Hence the Support to the
system is the Reverse Repo Rate => "Why
should I lend you at lower than RBI
Reverse Repo Rate when RBI can pay me
Rev Repo if I put my Money there?" (For
example 3.35% is the Support Rate for
inter-bank market). When There is
shortage of funds in the market => Why
should I borrow from you at a higher than
Repo Rate as RBI will lend me at Repo
Rate if I have a problem (till 1% of NDTL).
This is a Resistance Rate. You get a band
(Interest Rate Corridor) within the which
the Market is targeted to work. If people
work outside this corridor for a longer
period of time, the policy is not in sync
with the market requirement and
Monetary policy needs relook.
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7. Money Market
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