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Money Markets

Call Money

Liquidity Adjustment Facility

Important signals for the interest rate changes and the prominent tools useful for theliquidity management in the Indian money market are the bank rates, CRR and repo ratechanges. In this direction the Liquidity Adjustment Facility (LAF) by the RBI has beenan effective mechanism in the RBIs liquidity management scheme where it can absorbor inject liquidity on a day-to-day basis in a very flexible way, which in turn provides apassage for the call money market. The RBI in its monetary and credit policy of April,2000 announced the introduction of the LAF (Liquidity Adjustment Facility). TheScheme of Liquidity Adjustment Facility (LAF) will include (i) Repo Auctions and (ii)Reserve Repo auctions.

As per the scheme, Repo and Researve Repo auctions will be conducted on a daily basisexcept for Saturdays. The Repo tenor is one day except for the holidays and the Fridays.To account for the following Saturday and Sunday the maturity of auctions on Friday willbe three days. The funds available to the banks under the facility are supposed to be usedby them to even out the day-to-day imbalances in liquidity.

As per the policy statement the RBI has taken the launch of LAF in three convenient andprogressive stages so as to ensure a smooth transition. In the first stage variable rate Repoauctions with the same day settlement were introduced replacing the AdditionalCollateralized Lending Facility (ACLF) to banks and Level II support to Primary Dealers(PDs). In the second stage of the scheme Collateralized Lending Facility (CLF) to banks

and Level I support to PDs is to be replaced by variable rate Repo auctions. It wasindicated that the effective date for the second stage would be decided in consultationwith banks and PDs.

As the market developed most of the constraints in the operations of the LAF wereremoved. Hence the RBI is trying to make LAF much more efficient. On the basis of theprevious LAF operations and also on long discussions with the market participants theRBI ahs revised the earlier LAF Scheme, dated May 29, 2000. The new features of theLAF Scheme 2001-2002 are excerpted here from the RBI circular number4376/03.75.00/2000-01.

The Scheme

Under the scheme, (i) Repo auctions (for absorption of liquidity) and (ii) Reverse Repoauctions (for injection of liquidity) will be conducted on a daily basis (except Saturdays).But for the intervening holidays and Fridays, the Repo tenor will be one day. On Fridays,the auctions will be held for three days maturity to cover the following Saturday andSunday. The funds under LAF are expected to be used by the banks for their day-to-daymismatches in liquidity.

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Fixed Rate Repo Auction

The RBI will henceforth have an additional option to switchover to fixed rate Repos onovernight basis; but this option is expected to be sparingly used. For the purpose of suchRepos, the rates of interest intended to be offered would be announced as part of auction

announcement on the previous evening or before 10 a.m. on the day of auction, ifnecessary.

LONG-TERM REPO

In addition to overnight Repos, the RBI will also have the discretion to introduce longer-term Repos up to 14 day period as and when required.

RATE OF INTEREST

At present, auctions under LAF are conducted on uniform price basis. It has been

decided to introduce multiple price auction, in place of existing uniform price auctionon an experimental basis for one-month period during May 2001. Interest rates in respectof both Repos and reverse Repos will be, accordingly, based on the bids quoted byparticipants and subject to the cut-off rates as decided by the Reserve Bank of India, atMumbai. The Repo/ Reverse Repo rate in percent per annum expected by the tendererwill be expressed up to two decimal points rounded off to the nearest 5 basis points. Asthere will be no adjustment for accrued coupon, the cash flow will depend upon the Reporate emerging on a day-to-day basis.

MECHANICS OF OPERATIONS

i. The LAF auction timing is being advanced by 30 minutes. Bids will be receivedin tender forms at IDM Cell before 10.30 a.m., as against 11 a.m. at present. Aseparate box for the purpose will be kept at the reception on the Ground floor ofthe Central Office Building, the RBI, and Mumbai. Processing of the bids will bedone at IDMC. The auction results will be displayed by the Mumbai Office by 12non as against 12.30 p.m. present.

ii. The Repo will be conducted as Hold in Custody type, wherein the ReserveBank of India will act as a custodian for the participants and hold the securitieson their behalf in the Repo/ Reverse Repo Constituents Accounts. In pursuant tothis, the participants will have to give an undertaking as given in the respectivetender forms authorizing the RBI to act on behalf of them. The Reserve Bank ofIndia shall not, however, be responsible for any loss, damage or liability onaccount of acting as the custodian on behalf of the participants. A RepoConstituents SGL Account (RC SGL Account) and Reverse Repo ConstituentsSGL Account (RRC SGL Account) will be opened which will have institution-wise subsidiary records of the securities sold under Repo and securities boughtunder Reverse Repo. The RBI will have Subsidiary Accounts in the case of bothof these Accounts.

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iii. Upon successful auctions in Repos, the tenderers RC SGL Account will becredited with the required quantum of securities debiting the Banks SubsidiaryAccount/ Investment Account. Likewise, the tenderers Current Account will bedebited for the resultant cash flows and credited to the Banks Account. Thetransaction will be reversed in the second leg.

iv. In the case of Reverse Repos, on acceptance of bid, the tenderers SGL account/RRC SGL Account will be debited with the required quantum of securities andcredited to Banks Investment Account/ Subsidiary RRC SGL Account.Accordingly, the tenderers Current Account will be credited with the ReverseRepo amount, debiting the Banks account. The transactions will be reversed inthe second leg.

v. Transactions between the RBI and the counterparties including operation of theRC SGL Account and RRC SGL Account would not require separate SGL formsas provision will be made in the application form for the purpose. Likewise,transfer of securities from/ to the RBIs Investment Account and SubsidiaryAccounts in the Repo and Reverse Repo SGL account will not require signing of

SGL transfer forms. However, transfer from tenderers SGL Account to the RRCSGL Account will require completion of SGL form. In the case of ReverseRepos, tenderers will have the option to either use the RRC SGL Account routeor get their SGL Account debited for the purpose of transferring securities to theRBI.

vi. All securities including Treasury Bills will be priced at face value for Repo/Reverse Repo operations by the RBI. Accrued interest as on the date oftransaction will be ignored for the purpose of pricing of securities. Coupon, ifany, will be transferred to the RBI in the case of Repos, and the RBI will collectthe coupon, if any, on the due date and credit the same to the partys CurrentAccount in the case of Reverse Repos.

Eligibility

All Scheduled Commercial Banks (excluding Regional Rural Banks) and PrimaryDealers (PDs) having Current Account and SGL Account with the RBI, Mumbai will beeligible to participate in the Repo and Reverse Repo auctions.

Minimum Bid Size

To enable participation of small level operators in LAF and also to add furtheroperational flexibility to the scheme, the minimum bid size for LAF is being reducedfrom the existing Rs. 10 crore to Rs. 5 crore and in multiples of Rs. 5 crore thereafter.

Eligible Securities

Repos and Reverse Repos will be undertaken in all transferable Government of Indiadated Securities/ Treasury Bills (except 14 days Treasury Bills).

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Margin Requirement

A margin will be uniformly applied in respect of the above collateral securitiescomprising the Government of India dated securities/ Treasury bills. The amount ofsecurities offered or tendered on acceptance of a bid for Rs. 100 will be Rs. 105 in terms

of face value.

Settlement of Transactions

The settlement of transactions in the auction will take place on the same day.

SLR and Securities Held in Repo SGL Account

Securities held by the RBI on behalf of banks Repo Constituents SGL account andcredit balance in the RRC SGL Account will be counted for SLR purpose and acertificate will be issued to banks by the RBI on a fortnightly basis. As far as valuation

etc., for SLR purpose is concerned, extant DBOD instructions will apply.

Dissemination of Information

For a smooth transition to full-fledged operation of LAF, banks and PDs are beingprovided a back-stop facility at variable rate of interest, as a cushion over the normalliquidity facility at Bank Rate. Along with the auction results, the rate of interestapplicable to the back-stop facility for the concerned day will also be announced for thebenefit of the participants who wish to avail of such facility. Further, to facilitate betterbidding by the participants, additional information on the aggregate cash balances ofscheduled commercial banks maintained with the RBI, during the fortnight, on acumulative basis with a lag of two days as also weighted average cut-off yield will alsobe released as a part of the press release on money market operations.

Term Money Market

Term money market is the interbank market of more than 15 days maturity. The RBI hasreduced the minimum number of days to 7 from 15. This market is also affected by thereserve requirements of the banks. The RBI has taken two initiatives to develop themarket.

The All India Financial Institutions can take loans from the permitted lenders. Thecriteria of the banks and financial institutions, which participate in this market is suchthat there are no defaults in the market. The deposits are non-transferable and non-negotiable and the interest rate on the deposits is settled by the participants. Thesedeposits improve the depth of the market and increase the scope of the banks to investtheir short-term money in the market.

The removal of reserve requirements on the interbank borrowings except a minimumCRR of 3% has enabled the banks to finance their requirements up to a period of 3

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months. The Inter Bank Deposit rates are determined after comparison with other marketrates and adjusted to the CRR factor.

With these two initiatives the call market was stabilized as the fund requirements formore than 15 days are financed through the Inter Bank Deposits in this market.

CALL MARKETS IN OTHER COUNTRIES

Two markets which form the call money market in the USA: (a) Federal funds market (b)Call money market.

Federal Funds Market

Federal funds are defined as money available for immediate payment. The principalsource of immediately available money is the reserve balance. This is the balance whicheach bank maintains at the Federal Reserve Bank in its region of the United States.

Hence, this market was termed as federal funds market. Funds are transferred from one bank to the other only through the Federal Reserve Bank. These funds are readilytransferred into the appropriate reserve account immediately through the computer. Theduration of a federal funds transaction is usually one day (overnight) and it is extended ifnecessary.

PARTICIPANTS

Savings and loan associations, credit unions, and savings banks maintain deposits withcommercial banks or with the Federal Reserve Bank, which are made available forimmediate transfer to a customer or to another financial institution on need basis.Business corporations and state and local governments lend federal funds by executingrepurchase agreements with securities dealers, banks and other funds traders.

Borrowers of federal funds include securities dealers, corporations, state and localgovernments and non-bank financial intermediaries such as savings and loan associationsand insurance companies.

PURPOSE

Banks and other depository institutions must hold liquid assets in a special reserveaccount, equal to a certain fraction of the funds with Federal Reserve Bank. Supply offederal funds arises because some member banks have reserves on a given day in excessof reserve requirement. Demand for funds arises as other member banks on the same dayhave reserve deficits, which are generally transferred from one depository institution toanother when required. Apart from the commercial banks, the savings and loanassociations, credit unions, savings banks, securities dealers and non-bank financialintermediaries borrow from this market. Though the fed funds are borrowed by manyother users, this instrument is mainly used by commercial banks to maintain legalreserves with Federal Reserve Bank.

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OPERATIONAL MECHANISM

The funds are transferred readily by telephone, online computer or by wire, from oneaccount to the other after securities are purchased or whenever a loan is granted.

Federal funds transactions take the following forms. If both institutions have FederalReserve (lender and the borrower) bank accounts, they may instruct the Federal Reserveto transfer funds from the account of the lender to the account of the borrower overFedwire, the wire-transfer system of the Federal Reserve. Either of the party may initiatethe transaction. Alternatively, another institution (respondent) may maintain an accountwith an institution, which acts as a federal funds broker (correspondent). In such a case,the respondent bank informs the correspondent of its desire to sell federal funds, at whichpoint the correspondent reclassifies the respondents balance from demand deposits tofederal funds purchased. The correspondent frequently resells the funds to a third party inthe market. At times, if the transacting institutions/ banks, both are not located within thesame Federal Reserve district, then, the two Federal Reserve banks are involved in the

transfer of funds. In such a case, loan transaction proceeds in much the same way exceptthat two Federal Reserve banks are involved.

INTEREST RATES ON FEDERAL FUNDS

The federal funds interest rate is highly volatile every day; it tends to be most volatiletowards the close of the reserve maintenance period, depending on whether larger banksare flush with or short of reserves. There are no seasonal patterns/ fluctuations withwhich the funds rate tends to rise or fall.

GOVERNMENT POLICY TOWARDS FEDERAL FUNDS MARKET

This market is riskless and it is easy to invest excess reserves for short periods and stillearn some interest income. It is basically a daily management of daily bank reserves, andcredit can be obtained in a matter of minutes to cover emergency situations. Fed fundsserve the principal means of payment for securities and loans, and the funds markettransmits the effects of Federal Reserve Monetary Policy quickly throughout the bankingsystem.

Call Money Market

The call money market comprises an interbank call market, and the market betweenbanks on the one hand and security brokers and dealers on the other hand. Call money inthe US market performs a different function. The call loans represent short-term loans bybanks to security brokers and dealers for the purpose of financing their customerspurchases of common stock. Bank loans to dealers in government securities also formpart of the call loans. These loans are secured loans and the call provision allows thetermination of the loan by either the lender or the borrower on one days notice.Similarly, dealers in securities obtain loans from non-financial corporations,miscellaneous lenders such as state and local governments, foreign institutions, and

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insurance companies. This type of call money market does not exist elsewhere except inthe US. This market forms a part of capital market rather than money market, as themoney that is pooled here is lent to invest/ purchase the common stock. Since the moneydoes not roll into money markets, federal markets in international markets are known forhigh liquidity and returns.

In the UK, the call money market consists of interbank loans, loans by the clearing banksto the discount house (given on call basis) and surplus/ deficit positions between theclearing houses before approaching for final settlement with the Bank of England (centralbank of the country). This market is more similar to the American market than to theIndian market.

SUMMARY

The call money market is the part of the money market where the surplus funds ofthe banks are traded on a daily basis. Borrowers use funds to match short-term

mismatches of assets and liabilities and to match the CRR requirements. Thismarket is a measure of the liquidity of the overall money market.

Maturity period varies from 1 to 14 days.

Money that is lent for a day is called overnight money.

All private sector, public sector and co-operative banks, term lending institutions,insurance companies and mutual funds participate in this market. Primary dealers,DFHI and STCI can participate only in the local call money markets.

Interest paid on call loans is known as call rates and is calculated on a daily basis.

Call money markets are located in the cities that have the major stock exchangesin India, namely Mumnai, Kolkata, Delhi, Chennai and Ahmedabad. Mumbai hasthe largest market in India.

The RBI acts as a regular of the call money market, but neither borrows from norlends to it. It uses repos and open market operations to control the market.

An efficient call money market should be less volatile and provide andopportunity to the players to transact at comparatively stable rates of interest.

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Characteristics of the Indian Call Money Market

As indicated above, call money is the most important segment of the Indian financialsystem. It consists of overnight money and money at short notice for a period of up to 14days. The call money market essentially serves the purpose of equilibrating the short-

term liquidity position of banks and other participants. It is also the focal point throughwhich the RBI attempts to influence the short-term interest rates. Its average dailyturnover at more than Rs. 40,000 crore in recent period id the highest among all moneymarket instruments including Government securities market. In this market, while banksand primary dealers (PDs) are allowed to both borrow and lend, non-bank participantssuch as financial institutions, mutual funds and select corporates are permitted to onlylend. The demand for funds in this market is mainly governed by the banks need forresources to meet their statutory reserve requirements; it also offers some participants aregular funding source to build up short-term assets. It is, however, felt that the demandfor funds for reserve requirements dominates any other demand in the market. Viewedfrom this angle, it may be noted that total reserves transacted (i.e., aggregate borrowings)

in the call money market as proportion of aggregate cash balances maintained bycommercial banks with the RBI, on average, ruled around 32 percent in the recent period.

As regards the number of participants, apparently the market is very broad based as onthe borrowing side, there are as many as 169 participants (banks 154 and PDs 15)while on the lending side, apart from these 169 participants, there are additional 105participants taking the total to 274 (Table A1).

Table A1

Number of Participants in Call/ Notice Money Market

(as on March 12, 2001)

Category Bank PD FI MF Corporate Total

I. Borrower II. Lender

154154

1515

-20

-35

-50

169274

A typical characteristic of this market is that except PDs who are participating in bothsides of the market, there is hardly any bank that operates both as a borrower and lendersimultaneously on any given day. It is generally found that public sector banks with theirvast branch network in the country are generally the supplier of funds in the market whileforeign and private sector banks with their urban-centric structure coupled with theirrelatively advanced treasury operations are regular borrowers in the market.

Keeping this in perspective, the overall shares of various constituents based on their dailytransactions during the last two years are as follows:

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Table A2

Market Shares of Constituents in Call/ Notice Money Market

(In Percent)

Borrowings Lendings

Year Banks PDs Banks PDs Others19992000

6866

3234

5245

1111

3744

Note : a. Figures do not include operations of co-operative banks.b. Others constitute financial institutions, mutual funds and select corporates.

An analysis of participant-wise shares in both borrowings and lendings in call/ noticemoney market reveals a highly skewed nature of the market. On the lending side, StateBank of India (SBI) is the largest participant accounting for as much as 15 percent in1999 which, however, declined to 13 percent in the following year (Table A3). On the

whole, four public sector banks and five Financial Institutions (FIs) supplied to the tuneof 38 percent of the aggregate supplies for funds in the market in 1999 which dropped to31 percent in 2000. What is important to note here is that through there are as many as274 participants (Table A1) who are eligible to lend in the market, there are only 9participants as indicated above who control about one-third of aggregate lendings in themarket.

Table A3

Shares of Select Participants in Call/ Notice Money Market : Lending

(In Percent)

Year Banks FIs Total19992000

20 (15)17 (13)

1814

3831

Banks : Canara Bank, Central Bank, PNB and SBIFIs : ICICI, IDBI, LIC, SIDBI and UTIParenthetic figures relate to those of the SBI.

Similarly, on the borrowing side, the shares of only ten foreign and private sector banksaccounted for as much as 36 percent of aggregate borrowings in 1999 which increasedfurther to 39 percent in the following year (Table A4).

Table A4

Shares of Select Banks in Call/ Notice Money Market : Borrowings

(In Percent)

Year Banks

19992000

3639

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Select banks include ABN-AMRO Bank, Bank Nationale De Paris, Centurion Bank, CitiBank, Deutsche Bank, Grindlays Bank, HDFC Bank, Hongkong Bank, IDBI Bank andStandard Chartered Bank.

From this analysis, it needs to be noted that though apparently the market is quite broad

based, in reality, it is quite lopsided in both borrowing and lending segments. In otherwords, despite the market having the highest turnover in Indian money market, it lacksdepth and liquidity as absence of one or two major participants in either of the segmentsmay have the potential to cause slurp volatility in the market. This not only impairsefficient price discovery process in the market, but also necessitates more active liquiditymanagement practices by the RBI in order to keep interest rates within a reasonablecorridor.

Position since 1990s

Following the freeing of interest rates in call money market in June 1989, there had been

bouts of extreme volatility in call rates on many occasions during 1989-90. Despite theVaghul Committee recommendation that call money market should be made purely aninterbank market, with a view to reduce volatility and widen the market, the policyrelating to the entry into the call/notice money market was gradually liberalized since1990. In May 1990, three more financial institutions (viz., GIC, IDBL and NABARD)besides LIC and UTI were permitted to participate in the call/notice money market aslenders. In October 1990, with a view to further widen the call/notice money market andto bring about a greater integration in various segments of the money market, all theparticipants in the Bills Rediscounting Scheme who were not operating in the call/noticemoney market till then, were granted entry as lenders. Subsequently, eight mutual fundssponsored by public sector banks/financial institutions were also permitted to participatein the call/notice money market as lenders.

In April 1991, the policy relating to entry in the call/notice money market was furtherliberalized and it was decided to provide access as lenders to such entities as were able toprovide evidence to the RBI of bulk lendable resources. Such entities were required toobserve a minimum size of operations of Rs.20 crore per transaction and suchtransactions were to be routed through Discount and Finance House of India (DFHI)only. Furthermore, such entities were also required to give an undertaking that they hadno outstanding borrowings from the banking system. In April 1997, the facility of routingtransactions by these entities was extended to all the PDs as against only DFHI earlier,The minimum size of operations was also reduced from Rs.20 crore to Rs. 10 crore andultimately to Rs.5 crore and finally to Rs.3 crore in October 1997 and in May 1998respectively. Consequent upon the relaxations granted to entities for routing calltransactions, the number of entities routing their call transactions through PDs rosesharply. At present, there are 50 such entities.

Earlier only the public sector mutual funds were allowed to operate as lenders in thecall/notice money market but with a view to facilitate a level playing field, it was decidedin April 1995 to provide access to mutual funds set tip in the private sector and approved

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by the Securities and Exchange Board of India (SEW) also as tenders in the call/noticemoney market after these entities obtained specific permission from the Reserve Bank. In1996, 4 primary dealers, in addition to DFHI and STCI were permitted to operate both aslenders as well as borrowers in the call/notice money market. As of now, the number ofPDs has increased to 15.

As on March 12, 2001, there were 55 financial institutions and mutual funds operating inthe market as lenders, besides all scheduled commercial banks, co operative banks andprimary dealers which operate as both tenders as well as borrowers.

Shift in Stance In the RBI

There has been a change in policy stance regarding permission to non-bank participantsto operate in the call/notice money market. This issue was also examined by the InternalGroup to Examine the Development of Call Money Market in 1997 which had observedthat the call money market was an interbank market the world over. Furthermore, when

non-banks arc allowed to participate in the call money market, it partly distorts thesignals of liquidity conditions in the system. Analysis (lone by the group revealed thatintermediate lenders in call money were in a position to exploit the situation of tightmoney conditions and dictate terms to the banking system thereby causing unduevolatility in the call/notice money market. The view was that non-bank institutions shouldinstead be allowed to deploy their short-term funds in alternative money marketinstruments like Repos, Money Market Mutual Funds (MMMFs) and Certificates ofDeposit (CDs), etc. and until these markets develop, the existing non-bank participantsmay be allowed to continue in the call money market.

Similarly, following the recommendations of the Narasimham Committee II (1998), thegeneral consensus of members of the Standing Committee on Money Market (which wassince reconstituted as Technical Advisory Committee on Money and GovernmentSecurities Markets) was that ultimately we should move towards a pure interbank marketalong with only primary dealers, and in the meantime steps should be taken to widen therepo market and increase non-bank participation in other money market instruments.

Accordingly, in the Mid-Term Review of Monetary and Credit Policy for 1998-99announced in October 1998, the Reserve Bank indicated its intention to ultimately movetowards a pure inter-bank call/notice/term money market including PDs. It was indicatedthat measures would be taken simultaneously to widen the repo market and improve non-bank participation in a variety of other instruments and this would be implemented in amanner that existing lenders in the market would have operational flexibility to adjusttheir asset-liability structures.

It was decided, as a first step, that permission only to non-bank participants for routingtheir call transactions through PDs be withdrawn and other non-bank institutions(financial institutions and mutual funds) be allowed to continue in the call/notice moneymarket until such time the other avenues for short-term deployment of funds areavailable. Accordingly, in April 1999, it was indicated that permission given to non-bank

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entities to lend in the call/notice money market by routing their transactions through PDswould be available only up to end- December 1999. This permission was, however,extended in stages up to June2001.

Simultaneously, the Reserve Bank has taken several steps to widen the participation inrepo market as indicated below:

i. Following the amendment to the Securities Contract (Regulations) Act, 1956(SCRA) in March, 2000 delegating regulatory powers to the RBI to regulate, interalia, dealings in Government securities and money market securities, all those non-bank entities maintaining current account and SGL account with the RBI, Mumbaihad been permitted to undertake both repo and reverse repo.

ii. Minimum maturity for repo transactions was reduced to 1 day.

iii. State Government securities have been made eligible for undertaking repos.

iv. The RBI also opens its purchase window to impart liquidity to Treasury Billswhenever the situation warrants.

v. Clearing Corporation is being set up for money and securities settlement.

In addition to the above, the minimum period for trans1 in case of Certificates of Deposithas recently been abolished. This would provide an additional avenue to non-banks tolend shortterm funds to the banking system.

Policy Perspective and Recommendations

The Technical Group appreciated the need for non-banks to he phased out of thecall/notice money market in the interest of development of a risk-free short-term yieldcurve in the economy. Towards this end, the Group concurred fully with the viewexpressed by Dr. Y.V. Reddy, Deputy Governor of the RBI that complete withdrawal ofnon-banks from call money market should be co-terminus with the lull fledgedoperationalization of the Clearing Corporation. Keeping this in perspective, the Groupdeliberated on various suggestions in order to achieve a smooth transition to therepo/reverse repo market. These suggestions broadly relate to call money market andGovernment securities market including repo market.

Call Money Market

With regard to gradual phasing out of access to call money market by such non- bankparticipants as financial institutions and mutual funds, the Group recommends that suchaccess may he reduced in three stages by placing cap in relation to their average dailylending during April 2000 - March 2001 In the first stage, each such non-bank participantshould he allowed to lend only up to 70 percent of their average daily lendings in call

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money market during 2000-2001 for a period of three months which should come intoeffect at the earliest after March 31, 2001. In the second stage, access should he reducedfurther to 40 percent of their average daily lendings during 2000-01. The final stageshould commence with the setting up of Clearing Corporation or after a period of threemonths from the conclusion of the second stage whichever is later. The final stage by

which time the Clearing Corporation is expected to be established should last for a periodof three months. During this phase, the Group feels that access to call money marketshould be permitted to these participants to the extent of 10 percent of their average dailylending during 2000-01. This is considered necessary to enable these particular classes ofnon-bank participants to be familiar with the operations of the Clearing Corporations.After the end of this stage, these entities would not be permitted to lend in call moneymarket at all.

The Group appreciates that there is a strong need to gradualize the process of phasing outnon-banks from the call money market for ensuring their smooth transition to the repomarket as has been indicated above. However, there is a consensus that among the non-

bank participants, select corporates who route their funds through PDs may be withdrawnimmediately as these entities could always place their funds with PDs through the inter-corporate deposits (ICD5) route. Accordingly, the Group recommends that corporateslending in call money market should not be permitted to lend after end-June 2001.

Government Securities/Repo Market

With the phasing out of non-bank participants from call money market to repo/reverserepo market, it is expected that the latter would emerge as a vibrant short-term moneymarket for both banks and non-banks. In fact, it is envisaged that in future, both callmoney market and repo/reverse repo market would constitute a unified market toequilibrate short-term funds positions for both banks and non-bank participants becauserepo/ reverse repo (henceforth, it is indicated as repo market for convenience unlessotherwise stated) market would afford both borrowing and lending facility to non-bankparticipants. However, during the intermediate period, it is apprehended that fluids flowbetween these two markets may not be as smooth as one expects it to be eventually. Thisis because distribution of surplus liquidity and that of surplus securities over StatutoryLiquidity Requirements (SLR) in the banking sector are such that those who arepersistent borrowers in the market (i.e., foreign and private sector banks) do not maintainsufficiently large volume of surplus securities in their portfolio (Table 5) so as to enablethem to borrow easily from the repo market.

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Table A5

Distribution of Excess SLR Securities among Categories of Banks

(Rupees crore)

S.No.

Group of Bank Average holding of Excess SLR Securities

Percentage sharein total

1.2.

3.4.5.

SBI GroupNationalized Banks otherthan SBI GroupPrivate Sector BanksForeign BanksTotal

199928,32439,355

6,0544,219

77,952

200035,70346,455

8,7494,819

95,726

199936.450.6

7.85.4100

200037.348.5

9.15.0

100

Note: For this purpose required SLR investments have been worked out as 25 percent ofLiability to Others for the category of banks concerned. Excess SLR securities have been defined as investments in Government and other Approved Securities less

required SLR investments.

It may he worthwhile to note that while the average daily aggregate lending in call moneymarket by non-bank participants stood at Rs.7,672 crore during the years 1999 and 2000,average net borrowings by banks and PDs were Rs.3,4S8 CWIC and Rs.4,184 crore,respectively, during the period. As against this, the average surplus securities availablewith the foreign and private sector banks were at Rs. 11,920 crore of which the averagevolume of surplus securities with foreign banks was at Rs.4.519 crore during the period.Moreover, a part of securities held by PDs would also he available for undertaking repotransactions. Again, since these classes of entities are also more active in trading inGovernment securities market, the effective volume of surplus securities available for

repo for borrowing of funds would he lower for them, While the Group is aware thatchronic borrowers should need to reduce (heir call money borrowing keeping in view theasset-liability management (ALM) guidelines, it is generally perceived that theseborrowers could face some transition problems. However, considering the fact that non-bank participants such as financial institutions and mutual funds would be permitted tolend up to 70 percent of their average daily lending during 2000-200 1 for three monthsin the first phase, it is expected that market participants on both lending and borrowingsides would have sufficient time to adjust their portfolios accordingly without anydisruption in the market. Moreover, with the establishment of Clearing Corporation repooperations would not only become more efficient and the need for securities would berelatively less, it would also be possible to undertake repo transactions in non-

Government securities. Non-bank participants under the new set up may also like to buildup a portfolio of repoable securities for meeting their occasional short-term borrowingneeds over time. This may represent an additional demand in the debt market includingGovernment securities. Eventually, it is envisaged that since call money rates would behigher than the repo rates, banks with surplus SLR securities may act as conduits forfunds from the repo market to call market.

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Under the ambit of the Clearing Corporation, rollover of securities in repo transactionswould also become possible (provided it is not considered a short sale). Similarly, theGroup feels that securities obtained under reverse repo may be allowed to he used forundertaking repo. These apart at present repo is permitted only at Mumbai. Suchactivities may he allowed in other centers as well. The Group feels that since repo market

will attract larger volume of transactions in the wake of phasing out of non-bankparticipants from the call money market, there is a strong need to introduce a master repoagreement with uniform documentation and accounting standards. The Group, however,appreciates that such an effort is underway under the aegis of the Fixed Income MoneyMarket and Derivatives Association of India (FIMMDA). Though non-bank participantsarc allowed to invest in all other money market instruments with a much wider array ofmaturities, the Group has suggested that floating stock of Treasury Bills particularly atthe shorter end may he increased for providing an additional avenue to non-hankparticipants for deploying their short-term surplus funds.

Repurchase Agreements (REPOs)

Repo (Ready Forward Deal) is an agreement, which involves a sale of a security with anundertaking to buyback the same at a predetermined price at a future date. Thetransaction is called Repo from the seller side and viewed as reverse repo from thebuyers side. In other words, repo is an agreement with a commitment by the seller to buya security back from the purchaser at a specified price at a designated future date. Therepo represents a collateralized short-term loan, where the collateral may be a treasurysecurity, money market instrument, federal agency security, or mortgage-backed security.Repos may be contracted for as short a period as overnight.

A repo transaction essentially involves borrowing money at a price like other moneymarket instruments. A repo will help the holder of a security to acquire liquidity for ashort-term without necessary liquidating the security. The buyer of the security will havean avenue to deploy the surplus funds for a short-term. The government introducedRepurchase Agreements (Repos) in order to manage the excess of liquidity in the system,and also to even out interest rates in the call/notice money market.

Following is the diagrammatic representation of a Repo deal.

Figure 1

(1) Stage IBonds or G-sec

Collateral (Cash)

(2) Stage II Settlement Bonds or G-secRental Fee

Collateral (Cash)Interest

Market Participants

15

Lender

Lender Borrower

Borrower


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Earlier, only banks, Discount and Finance House of India Ltd. (DFHI) and other financialinstitutions, which maintain both an SGL (Subsidiary General Ledger) account as well ascurrent account with RBI, Mumbai, were eligible to participate in the repo market.However, subsequent to the amendment of the Securities Contracts (regulation) Act

(SCRA), 1956, the repo market has been widened to cover all such non-bank entitiesholding both current and SGL accounts with RBI, Mumbai, including mutual funds, thus,increasing the number of eligible non-bank participants to 64 from the earlier 35. Theseentities can now borrow as well as lend in the repo market. These measures are expectedto give a fillip to the repo market, besides enabling better cash and asset-liabilitymanagement by non-bank institutions.

Repo vs. Call Money

Banks borrow in the call market to meet their requirements and these borrowings areunsecured in nature. However, if a bank borrows the same amount through a repo, the

lender will receive a security duly transferred which will be held in his name till thereversal of the transaction takes place. Through very unlikely, in the event of the reversalnot taking place, the lender does not suffer any loss since the transaction is tantamount toan outright purchase of a security. Hence, the borrowing under Repo is a securedborrowing. These transactions are undertaken mostly between the bankers on the samelines as call money transactions, but they may also be undertaken on the NSE WholesaleDebt Market segment. Considering the secured nature of borrowing, the interest rate islikely to be lower than the rate prevailing in call. However, the difference is not veryconspicuous since the default risk in a call loan is also significantly low.

The following describes the operational aspects of a Repo.

Size of the Loan: It is usually the borrower who initiates the transaction and decides thequantum of the borrowing depending on the requirement. However, there will also beinstances where banks would like to buy the securities for a short-term as part of theirSLR management, in which case the size depends on the need for securities to make upfor the SLR shortfall of the Bank.

In case of RBI, tenders should be submitted for a minimum amount of Rs. 1 crore(worked out on the basis of face value of securities) and in multiples of Rs. 1 crore.

Selection of Security: The RBI announces the nature of securities eligible for Repotransactions. All the GoI securities and Treasury Bills and PSU bonds which are in thedemat form are eligible for Repo transaction, subject to the condition that the transactiontakes place at Mumbai and is reported to the RBI, Mumbai. As of now, consequent uponthe delegation of powers by the government and as a part of development of the repomarket, even State Government Securities have been made eligible for undertaking repos.

Interest Rate: The interest rate on the borrowing will be mutually negotiated dependingon the term, amount and the prevailing call money and term money rates.

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Settlement

The RBI operates the government securities settlement system for those having SGLaccounts in the public Debt Office through delivery versus payment. Under this system,

trades are settled on a gross trade by trade basis with irrevocable final settlement takingplace simultaneously for securities and funds, after ensuring that there are sufficientfunds in buyers account and sufficient securities in sellers account. In view of increasedvolumes in transactions, the RBI proposed to introduce a scheme for automaticinvocation by the SGL account holder of undrawn refinance/liquidity support from theRBI for facilitating smooth securities settlement. The facility will be available only tobanks and PDs, subject to adequate safeguards. The SGL also provides for details of thereversal transaction. RBI will maintain a Constituents Repo SGL account for the purposeof settlement. Securities held by the Reserve Bank of India on behalf of banks in theRepo SGL accounts will be eligible for SLR purposes. The Reserve Bank will issue SGLBalance Certificate indicating the details of total holdings of bank/institution and total

loan-wise securities held in the Repo Constituents SGL account as on any date. Tosimplify the provision of liquidity, in case of reverse repo auctions, successfulparticipants who are eligible to draw refinance from the RBI will be granted refinanceagainst collateral as per the existing procedures. The other successful bank/institutionsnot eligible for refinance will be provided liquidity support in the form of reverse repo asper the existing procedures.

The following example explains the computation involved in a Repo transaction.

Illustration 1

Bank A proposes to borrow on 20.03.20x1 an amount of Rs. 100 cr. from Bank B underrepo for a period of 14 days at an interest rate of 12%. The security for this transaction is13.40% GOI 20x1 whose interest payments are due on 24 th June and 24th December. Thecurrent market price of the security is Rs. 102.50.

Bank A sells 13.40% GOI 20x1 for a face value of Rs. 100 cr. to Bank B at the currentmarket price of Rs. 102.50. The cash outflow to Bank B will be as under.

Value of the security at Rs. 102,50,00,000.00Interest for the period Rs. 3,20,11,111.0024.12.20x0 to 19.3.20x1 (86 days)Total Rs. 105,70,11,111.00

This actual amount borrowed will, therefore, be Rs. 105,70,11,111

Since the contract envisages payment of interest on the borrowing at 12% for 14 days, theamount of interest is Rs. 48,65,147. Hence, the amount to be paid by Bank A to Bank B

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on the reversal date is Rs. 106,18,76,258. Hence, the price of the buyback of the ecuritywill now be worked out as under :

Amount to be paid Rs. 106,18,76,258.00Interest from 24.12.20x0 to 3.04.20x1 (100 days) Rs. 3,72,22,222.00

Price of the security Rs. 102,46,54,036.00

The following points need to be borne in mind while working out the cash flows:

a.While the amount of borrowing is decided by the borrower the actual cash flowdepends on the security selected due to its market price, and the interest accrued onthe security from the last date of interest payment till the date of transaction. Theholder of the security is entitled from the last interest payment ate till the date ofsale.b. Once the actual cash flow is determined, the interest cost is worked outbased on the terms of agreement with reference to interest rate and the term of

borrowing.c.Once the amount of the reverse flow is determined, the price of the security is tobe worked out depending on the accrued interest on the security from the last dateof interest payment till the date of reversal of the transaction.d. Interest with respect to GOI securities is computed on the assumption of30 days a month and 360 days a year whether transaction is an outright sale or arepo. Hence, January and February are assumed to have 30 days each. Similarly, theremaining number of days for December is considered as 7 (30-23) since, interest ispaid on 24th December till 23rd December.e.Interest with respect to borrowing is calculated for the actual number of daysbased on 365 days a year.

A repo is transacted as follows: Suppose Bank X needs funds for a short-term. It sellsT-Bills to Bank Y (sale agreement) and simultaneously agrees to buy the same after aspecified time at a slightly higher price (purchase agreement). The dofference betweenthe prices represents the interest payable by Bank X to Bank Y. The transaction helpsBank Y since it gets the yield on the funds deployed through it runs the risk that the priceof the security may drop in the meantime. The RBI makes funds available to the banksunder repos, directly or through DFHI (Discount and Finance House of India) andSecurities Trading Corporation of India. The RBI allows repo transactions only betweenbanks. In addition to T-bills, all dated central government securities can be used forrepos.

Repo Rate

The annualized interest rate at which the funds were transferred by the lender to the borrower is called the repo rate. The possible rate of borrowing through a repotransaction is lower than the rate on the same amount borrowed in the unsecured orinterbank loan. This is because the repo is a collateralized transaction where the ratedepends upon the creditworthiness of the issuer of the security and it is somewhat higher

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than the creditworthiness of the seller. Some other factors also influence the repo rate likeliquidity of the security or guarantee and relevant rates of other financial instruments inthe money market.

The repo transaction can be divided into two stages (first leg and second leg) viz. selling

of the security and repurchasing of the same security. Sale price of the security in the firststage depends upon the market price for outright deals and for a date, which is very nearin the future. Sale price is determined on the basis of cash inflow and tax aspects on thetransacted funds in the second stage, which is for a future date. This is because of tworeasons. First, as the instrument is sold to the buyer in the first stage, the ownership righttransfers to the buyer from the seller for the period of repo agreement. The coupon rate ofinterest accumulated for that period also has to be transferred to the seller. The amount ofinterest accrued for the broken period has to be remitted to the seller by bthe buyer in thefirst stage. In the second or repurchase stage, the initial seller or the present buyer has topay the accrued interest for the broken period to the earlier buyer or the current seller.

Both spot and forward transactions are present in the repo agreements. The required reporate is found by calculating the sale and repurchase prices after adjusting the accruedcoupon rate of interest. The excess of the coupon rate in the first stage of repo over thesecond stage of the repo gives the coupon rate of interest for the total period of repoagreement. Hence the method of price adjustment of a repo transaction varies directlywith the relationship between the net coupon interest rate and the total amount of repotransaction, which is determined on the basis of the agreed amount of funds transferred. Ifthe current yield is lower than repo rate a capital loss will occur due to the adjustment inthe repurchase price. On the other hand, capital gain will occur if the repo rate is lowerthan the current yield resulting in the downward adjustment of the repurchase price.

Adjustments in price at the repurchase stage are not required if both the repo rate andcoupon interest are equal in which case the repurchase price will be equal to the sellingprice of security.

Through the repo agreements are based on the collateral there is still element of risk,related to the guarantee in the form of counterparty risk and the issuer risk. The investorcan offset the counterparty risk by liquidating the securities kept as collateral.

Both seller and lender usually hold cash or some other securities against the risk of non-return of the lent securities according to the repo agreement. Generally the realizablevalue of the guarantee or securities should be more or equal to the amount of theexposure of the risk. Another risk that is possible is the illiquid collateral.

Standard accounting practices exist for treating repo agreements and the valuation ofcollateral. However, the collateral securities are generally calculated on the basis ofcurrent market price plus accrued interest (on coupon bearing securities) in the period upto the maturity date of the agreement excluding a margin or haircut. The haircut is anadjustment for offsetting the market risk to save the borrower or lender from thetransaction price movements. The amount of the haircut is determined by the period of

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repo, coupon rate of interest of the securities and the risk exposure involved in thesecurities.

As the variations in the market prices of securities have effect on both the lender andborrower, making to market is the most popular method that is used by both of them to

act accordingly. Based on this if the market values of the repo securities drop beyond aspecified point further collateral is to be supplied by the borrower. In contrast the lenderreturns all the excess collateral remitted by the borrower if the market values go upsubstantially.

Advantages of Repos

Repos have the following advantages :

The amount of activity in the repo market will increase the turnover of the moneymarket, resulting in the enhanced liquidity and depth in the market.

As a tool of financing the Repos would cause an increase in the turnover in the

debt market. It also causes increase in the volumes of dealings by the dealers.Hence the repos are a cost effective and efficient way of improving the liquidity ofthe securities transacted in the secondary markets.

As repos enable the traders to take convenient positions to go short or long in themarket the activity of debt markets increases. This flexibility enables one to manageefficiency the cash flows by acquiring in a bullish scenario and disposing off in abearish environment.

Institutions and corporates see repos as an inexpensive way of financing and canborrow and invest at market rates.

In India the growth of the debt markets and hedging activities are on low ebb

because of the absence of action term money market. A money market can beeffectively formed if a large number of repo transactions for varying structures aretraded in the market particularly in the interbank market.

Repos are also useful to the Central Bank in the way they can use them as a partof their open market operations to maintain the liquidity of the market and also toreduce fluctuations in the money market especially call money rates. The centralbank uses the bank reserves and call rates in such cases.

Developments in Repo Market

While the above describes the transactions between banks, Repo transactions may also be

entered into by the RBI and NBFCs. Earlier, NBFCs were only permitted to enter intoReserve Repo transactions. It means that NBFCs could buy securities in the first stageand then reverse the transaction in the second stage, but they can now enter into Repos.Thus, Repo is an avenue of NBFCs to develop short-term surplus funds, but not anavenue to raise funds.

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However, on 10th October, 2000, flowing the recommendations of the NarasimhamCommittee II, the Reserve Bank took several steps to when the participation in repomarket such as:

i. Permission to non-bank participants maintaining current and SGL accounts with the

RBI, Mumbai to undertake both repo and reverse repo;ii. Reduction in minimum maturity for repo transactions to 1 day;iii. State government securities being made eligible for undertaking repos; andiv. Opening of its purchase window to impact liquidity to government securities

whenever the situation warrants.

The RBI undertakes Repos with banks as part of its monetary management. When theRBI enters into Repo transactions, it sells the securities to banks with an undertaking tobuy them back. Thus, the liquidity in the system is sucked out for the term of the Repo.The RBI can add liquidity to the system by entering into reverse repos with banks. Eitherof these actions depend on the objective of the Central Bank. The RBI can also use these

transactions as a signaling mechanism for short-term interest rates. These transactions canalso help banks manage their SLR requirements.

Box 1 : Efficient Money Markets Grow Repo-Centric

By definition, a repo short for repurchase is a combination of spot and forwardtransactions. It involves a spot purchase (sale) and a forward sale (purchase) between two parties, both now and in the future. In either case, both cash and securities getsimultaneously exchanged. The forward stage of the transaction provides the fundamentalbasis for determining the repo-interest rate. A repo serves several functions. Firstly, itserves as a collateralized fixed-rate loan for a short period. In this function, it becomes abetter substitute for a call-loan. In case of call-loans for more than one day, interest rates

are recontracted on a daily basis, whereas in case of a repo, the rate can be either fixed orvariable for the period of transaction. Secondly, repo-borrowing provides the creditorwith a collateral and low-cost alternative to short-period deposit-borrowing. Therefore,the repo rate equilibrates both these markets. Thirdly, the forward or first stage of therepo transaction creates the scope for speculation in the interest rates in the securitiesmarket. As a result of such speculation, short selling of securities can serve a healthyprice discovery function. With such healthy speculation, the desired forward exposurecan be obtained at a transaction cost lower than in a real forward market. This, of course,sounds somewhat surprising as the scope for standardized contracts entail lower cost dueto economies of scale, but it is true. Finally, a repo markeet can be used for hedging riskswith an advantage over the forward market, as the former affords an array of maturitiesthat is less restricted than an over-the-counter (OTC) standardized forward market.

ISSUING PROCEDURE

The Reserve Ban of India issues press releases indicating the date of auction, the last dateand time for submission of tenders, details of securities offered such as, thenomenclature of the securities, their sale prices and the Repo period from time to time.The participants interested in quoting the bids need to duly fill the tender form (format

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given in Appendix I) and send it to the Reserve Bank of India, Securities Department,Mumbai, Separate tender forms need to be submitted for each bid in case of multiple bidsby a single tenderer. Tenderers are required to state Repo rate expected by them inpercentage (up to two decimals) per annum (365 days). The total amount payable by asuccessful tenderer to the RBI on purchase of securities will include the sale price quoted

by the Reserve Bank in addition to the accrued interest on the security.

Acceptance of Tender

The Reserve Bank will determine the total amount of Repos to be offered at each auctionon the basis of tenders received, and it will have the full discretion to accept or reject anyor all of the bids or make partial allotment without assigning any reason.

The setting up of Clearing Corporation of India (CCI) has upgraded the cash settlementsto the Real Time System. The wholesale investors, banks and mutual funds settle cashtransactions in government securities. T-Bills, bonds, in the CCI. The entities have to pay

after netting the transactions. This allows the banks and other wholesale investors toleverage their enhanced cash position. The corporation wants to build a war chart by wayof settlement guaranteed fund, by the entity exposures to their contribution to the fund.CII wants to make the process of transacting settlements by building a data link-up (pipeline) with the RBIs Negotiated Dealing System, besides provides a platform to boostRepo transactions. It seeks to remove the risk in trading non-equity derivatives byguaranteeing all trades.

Announcement of Auction Results

The result of the auction, viz. the Repo rate (cut-off rate) up to which bids have beenaccepted, would be displayed at the Reserve Bank of India, Mumbai on the same day.Repos will be offered to all tenderers who have tendered bids at or below the cut-off rate,at the respective rates quoted by them. The successful tenderers can collect theAcceptance-cum-Deal Confirmation Advice (specimen in Appendix II) and SGL transferforms immediately after announcement of auction results on the date of the auction. Theycan also take delivery of SGL transfer (credit) advice from PDO, RBI on the same day.The amount to be paid to successful bidders will be debited to their current account withthe RBI.

Box 2 : Terms and Conditions for Fortnightly Repo Auctions

1. Auctions for Repo on Multiple price basis will be conducted by Reserve Bankof India at Mumbai as per the dates given in the Calendar for Fortnightly RepoAuctions under LAF.2. All transferable Government of India dated securities and Treasury Bills will bethe eligible securities for Repo auctions.3. bids will be received for a minimum amount of Rs. 5 crore and in multiples of Rs.5 crore thereafter.4. All Schedules Commercial Banks (excluding RRBs) and Primary Dealers (PDs)maintaining SGL and Current accounts with RBI at Mumbai will be eligible to

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participate in the Repo auctions.5. Bids should be submitted in the prescribed form on the date of auction in sealedcovers indicating Fortnightly Repo Auction on the top of the envelope addressed tothe Chief General Manager, Internal Debt Management Cell, 16 th Floor, ReserveBank of India, Central Office, Mumbai-400001 and deposited in the box kept at the

Reception on the Ground Floor of the General Office building, RBI, fo the purpose,before 10.30 a.m.6. single or Multiple bids at different rates are permissible; separate tender formshould be submitted for each bid.7. The Repo rate in percent per annum expected by the tenderer should be expressedup to two decimal points rounded off to the nearest 5 basis points.8. The Repo will be conducted as Hold-in-Custody type of Repo. A constituentsSGL Account called Repo ConstituentsSGL Account will be opened with ReserveBank of India as a custodial account. Securities will be held by the RBI on behalf ofthe participants in this account in all Repo operations. The RBI would holdGovernment Securities sold by the Bank under Repo in the constituents account

(Repo Constituents SGL Account) on behalf of the counterparties during the repoperiod.9. For the purpose of Hold-in-Custody Repos, the applicants will have to authorizethe RBI to transfer securities to/from custodial accounts by crediting/debiting theiraccounts based on their application/bid form. They will also have to authorize theRBI to provide for cash flow adjustments and for transferring coupons to the RBI. All bank/PDs will have to authorize the RBI to accordingly credit/debit their currentaccounts and Repo Constituents SGL Accounts as the case may be. Accrued intereston the security will be ignored for the pricing of the security. Coupon, if any, will betransferred to the RBI in the case of Repos.10. On the basis of the tenders received, the RBI will determine the cut-off rate up to

which bids will be accepted.11. There will be margins for the Government if India dated securities and eligibleTreasury Bills. The amount of securities to be offered or tendered on acceptance of abid for Rs. 100 will be Rs. 105 in terms of face value.12. The successful tenderers Current Account with the RBI will be debited as per thecurrent procedure under Repo facility. The tenderers Repo Constituents SGLAccount will be credited simultaneously. On the expiry of the Repo period, thetenderers Constituents SGL Account will be debited and Current Account credited asper the date, amount and rate of interest indicated as the case may be. For instance, ina Repo auction where bid amount accepted is Rs. 420 crore at a cut off rate of 6.25percent he calculations of amount of cash outflow in the first leg and amount of cashinflow in the second leg (with interest) will be as under :

Leg 1 : Tenderers Current Account Dr. Rs. 420 cr.Tenderers RC SGL Account Cr. Rs. 441 cr.

= (Amt. Of bid x 105)/100.Leg 2 Tenderers RC SGL Account Dr. Rs. 441 cr.

Tenderers Current Account Cr. Rs. 421,00,68,493= (Amt. Of bid + interest for 14 days at 6.25%)

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13. Securities held by Reserve Bank of India on behalf of banks in the RepoConstituents SGL Account will be counted for SLR purposes. As a custodian ofsecurities, the Securities Department of the Reserve Bank of India will issue SGLbalance certificates, which would give details on total holdings of the bank and total

loan-wise securities held in the Repo Constituents SGL Account as on any date.14. The settlement of transactions in the auction will take place on the same day ofthe auction.15. The results of the auction will be announced through the Press Relations Divisionby 12.00 noon and the same would also be displayed at Mumbai Office, RBI, MainBuilding, Fort, Mumbai 400001.16. Tenderer should check for himself/herself the result of the auction and ifsuccessful, collect the acceptance cum deal confirmation advice from SecuritiesDepartment, RBI, Fort, Mumbai 400001 before 2.30 p.m.17. It will be binding on the successful bidders in the auction to accept the allottedamount of securities in full at the rate emerging in the auction. if the successful

bidders do not honor the allotment, they will be subject to penal action to the extent ofbeing debarred from participating in the auctions for a period of one year.18. The Reserve Bank reserves the right to accept or reject any or all the tenderswholly or partially, if deemed fit, without assigning any reason.19. Reserve Bank of India shall not be held responsible for any loss, damage liabilityon account of acting as the Custodian on behalf of the participants.

Payment

On the date the RBI repurchase the securities the tenderers current account will becredited with the amounts (that is specified in the acceptance-cum-confirmation advice),

while debiting their SGL account with the face value of the security. The tenderers cancollect the relative SGL transfer (debit) advice from the Public Debt Office on the sameday.

Repo/Reverse Repo Auctions under Liquidity Adjustment Facility

The Fixed Rate Auction system and ACLF for banks along with Level II support for PDswas replaced by a variable interest rate auction system on uniform price basisconducted by the Reserve Bank of India. In case of the RBI, tenders should be submittedfor a minimum amount of Rs. 1 crore and in multiples of Rs. 1 crore. Only banks andPDs maintaining SGL and current accounts with the Reserve Bank of India at Mumbaiare eligible to participate in the repo auction. Bids for repos have to be submitted before10.30 a.m. on all working days, Monday through Friday. Multiple bids can be submitted.There will be no auction on Saturdays. The results of the auctions will be announced by1.00 p.m. The settlement of transactions in the auctions will take place on the same day.But for intervening holidays, the repo auctions will be for one day except on Fridays; onFridays, the auction will be for three days or more maturing on the following workingday.

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The objective of RBI in conducting the Repo/Reverse repo auctions is to improve theshort-term liquidity management in the system and to remove the imbalances in theinterest rates of the call/notice money market.

Box 3 : Implications for Securities Market

The latest credit policy serves the three most important macro-level objectives successful completion of the Governments borrowing program in a cost-efficientmanner, ensuring adequate liquidity in the system and continuing to foster anenvironment for softer interest rates admirably well. It does so through a combinationof positive statements of intent and specific policy measures.

Phasing out of the CLF facility and placing of restrictions on banks in respect of their callmoney market borrowings and lendings is sure to give a boost to the repo market. Thatthe combination of high liquidity in the system and lack of prudential restrictions onlending and borrowing through the call money market can be dangerous was broughthome forcefully by the Madhavpura Cooperative Bank case. Hence the anxiety, on the

Reserve Bank of Indias part, to enforce discipline by limiting access to the call moneymarket to only those participants who need it for purposes of short-term liquiditymanagement; the decision to impose restrictions on the quantum of lending andborrowing by individual participants is quite understandable.

In this context, the proposed introduction of a new product by the Clearing Corporationof India Ltd. (CCIL), called CBLO (Collateralized Borrowing and Lending Obligation),along with a platform for trading in it with the added facility of straight-throughprocessing through the intermediation of the corporation, could not have come at a moreopportune time. CBLO, which is a variant of tripartite repo, will not only bolster demandfor repo market operations but may well herald the development of a term money market

in India.CCILs operationalization has seen the RBI mandating that settlement of all repotransactions be done through the corporation. The facility of guaranteed settlementextended by the corporation to counterparties to every trade serves to mitigate the risksinherent in the process, and would give comfort to the central banker that the systemicrisk in settlement will be taken care of.

The exhortation to banks to introduce a flexible interest rate system for all new deposits isaimed at offering better maneuverability in managing the interest rate risk and protectingtheir spreads. Reiteration of the policy to continue issuing Floating Rate Bonds (FRB)and the announcement that a working group will be set up for suggesting operational and prudential guidelines for operationalizing STRIPS trading are also steps in similardirection aimed at enlarging the scope for asset liability management by the banks.

By announcing the setting up of a working group to fix the limit for call moneyborrowings by PDs and reviewing the apportionment of liquidity facilities, as betweennormal and back-stop, the central bankers has signaled that the facility of special liquiditysupport and the practice of unrestricted reliance on call money market borrowings maynot continue for long. Like other players, PDs must evolve normal market mechanisms to

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find their operations.

PDs have been replying heavily on the call money market to fund the purchase ofsecurities at auctions, as also to stock them up when the market turns bullish. Once aceiling is imposed on their call money borrowings, however, their only resource to

funding would be through the repo market, and this will compel them to rely on theirstock-in-trade for their funding requirements.

Moreover, the current system of SGL account management, with its restrictions on same-day purchase and sale of securities and on the roll-over of repo contracts, handicaps theiroperations. Trading in the CBLO product, proposed to be introduced by CCIL shortly,will help to remedy this. Against a floating charge in its favor on the repoable securitiesof a member held in the CSGL account, CCIL will permit the borrowing through theCBLO to be created; the holder of CBLO will be able to trade the same in the secondarymarket.

Once may even buyback its own CBLO, liquidate the borrowing and get its securitiesreleased. In addition, members will be free to use securities held in the CSGL accountthat are lien-free, and will also be able to substitute them by other repoable securities atany time. Such an arrangement will afford PDs the much needed flexibility in their day-to-day operations.

All entities having SGL accounts are being advised to become members of the NDS(Negotiated Dealing System at RBI) before May 31. Thus, soon , a majority of the G-seetrades will get settled through CCIL. With CCIL underwriting the market risks inherentin settlement of the bulk of G-see trades, enhanced use of NDS will see greatertransparency and better price discovery and the system will move towards less reliance on

brokers. This should do a lot of good to the market as a whole.

Another specific area of policy direction is the proposal to retail government securities bycommercial banks through their branch network.

The credit policy exhorts banks to promote this mew line of business by offering to makethe market in individual securities by giving two-day quotes. By formulating a schemewhereby bank branches may permit automatic lending against pledging of securities, banks cannot only garner good business but also active G-see trading in the retailsegment.

Finally, the credit policy announced the winding down of the Satellite Dealer (SD)system. The scheme never really took off. With their thin capital base, SDs were totallydependent on the market for liquidity support, through repos.

With the repo market not quite developed, in the absence of liquidity SDs could not servethe policy objective of retailing G-sees effectively. Meanwhile, PDs have come into theirown and are now willing to expand their geographical reach. Even banks are inclined toenter the retail market. In such a situation, there is hardly any role for the SD; no tears

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need, therefore, be shed for the demise of this institution.

Secondary Market Transactions in Repos

The RBI through the SGL accounts settles the secondary market trading in the repos and

notifies the volume, rates and the period of repos on a weekly basis. The weekly averageof repo volumes in the secondary markets (based on the SGL) was at Rs. 788 crore in1998-99 and increased to Rs. 1,591 crore in 1999-2000. The average weekly transactionsin the first six months of 2000-01 were Rs. 1,782 crore. In the secondary market repos arebeing traded primarily on the Central Government securities. The volume of repos on T-bills have also shown increasing trend from Rs. 29 crore average amount in 1998-99 toRs. 134 crore of weekly average in 1999-2000.

When the volume of transaction of repos is very high the rates fall to a low of 2% andnormally the average rate is 6-8%. With the central bank deciding to make the call marketa pure interbank market, the movement of participants from the call market to the repo

market is poised to increase the activity and the volumes in the repo market. Theimportant blocks in the growth and smooth operation of the repo market are theimprovement of liquidity for only a few securities and lowr volumes when compared toother markets.

Box 4 : Excerpts from Annual Monetary Policy 2004-05

Following the announcement in the mid-term Review of November 2003, the LiquidityAdjustment Facility (LAF) was reviewed, taking into account the recommendations ofthe internal group constituted for the purpose and suggestions from the marketparticipants and experts. The revised scheme came into effect from March 29, 2004. Asper the revised scheme, 7-day fixed rate repo auctions are conducted on a daily basis. It

was indicated that the repo rate will be fixed by the Reserve Bank from time to time. On areview of macroeconomic developments, it is considered desirable to keep the 7-day reporate at 4.5 per cent at present. It may, however, be indicated that under the revisedScheme, RBI will continue to have the discretion to conduct overnight repo on longerterm repo auctions at fixed rates or at variable rates depending on market conditions andother relevant factors. The Reserve Bank will also have the discretion to change thespread between the repo rate and the reverse repo rate as and when appropriate.

Liquidity Adjustment Facility Revised Scheme

Following its announcement in the mid-term Review of November 3, 2003, the Report

of the Internal Group on Liquidity Adjustment Facility was put in public domain onDecember 2, 2003 for wider dissemination and comments. Thereafter, the Report wasdiscussed extensively with market participants and experts. Taking into account therecommendations of the Internal Group sand the suggestions from the market participantsand experts, the revised LAF scheme was operationalised effective March 29, 2004through : (i) 7-day fixed rate repo conducted daily and (ii) overnight fixed rate reverserepo conducted daily, on weekdays. Further, in order to enable market participants tomeet their prior commitments based on their existing operations, the 14-day repo,

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conducted on a fortnightly interval, is being continued with the existing features, forsome time. The international usage of Repo and Reverse Repo terms would beadopted, but from a future date after giving market participants adequate time for systemchanges.

Repos in Other Countries

In the US, repos could be treasury obligations, agency issues, mortgage-backedsecurities, corporate bedt issues or money market instruments such as NCDs. The periodcould be between one day and several months. At the end of the period, the seller getsback the security and the purchaser gets back the funds that he provided together with theaccrued interest. The major players in the repo market are banks, savings and loaninstitutions and non-bank security dealers.

In Europe, the stock lending and Repo Committee will constantly will review theguidelines on the operations of the repo market. Some specific and additional issues are

to be covered by the parties to the contract. These include legal documentation, credit riskassessment and the margin levels. Information regarding the collateral is to be exchangedby the parties at the point of trade. The pricing system is also determined at this stage.The benchmarking rate for the large European repo market is known as Europe. Thecollateral or the gift-edged security underlying the repo transaction is known as theEurope GC. A representation panel of prime banks provides daily quotes of the rate,rounded to two decimal places, that each Panel Bank believes one prime bnk is biddinganother prime bank (and offering money) for term repo on Europe GC. Europe is quotedfor spot value (T+2) and on an Act/360 day count convention. It is displayed up to twodecimal places. The range of Europe quoted maturities is overnight, 1,2 and 3 weeks and1,2,3,6,9 and 12 months.

Box 4 : International Repo-Market

International repos are so big in size today that their potential impact on the internationalfinancial system cannot be ignored. Through the statistics are hard to come by andsometimes of hardly reliable accuracy, according to the Bank for InternationalSettlements and the International Securities Market Association, the international repooutstandings are estimated at around US$ 1200 billion in 1998 or about 8 percent of therepos in sovereign securities in the world. Financial deregulation and technologicaladvancement, coupled with the inexorable march and inclination towards globalizationhave lent a helping hand in generating demand for new financial instruments formanaging risks and portfolios. Internationally, repos have always proved to be cost-

effective, conservative in risk content and complimentary to domestic portfolios inimproving the yield prospects. In all, the international repos serve as an attestedalternative and approved adjust to interest and currency derivatives, for managing theinterest and exchange risks.

SUMMARY

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Repos are ready forward deals or agreements involving sale of a security with anundertaking to buyback the same at a predetermined price and time in future. To theseller, it is known as a repo and to the buyer it is known as a reverse repo.

The market participants in repos are: banks, DFHI, financial institutions, non-

banking entities like mutual funds that hold current and SGL accounts with the RBI. The operational aspects of a repo depend on: size of the loan, selection ofsecurity, interest rate and settlement system

The procedure to issue repos involves the acceptance of tenders, announcement ofauction results and the payment.

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Appendix 1

Tender Form for Fortnightly Repo Auction

The Chief General Manager

Internal Debt Management CellReserve Bank of IndiaMumbai

Tenderers RC SGL A/cNo. with SecuritiesDepartment

Tenderers CurrentA/c No. with D.A.D.

Dear Sir,

Tender for Fortnightly Repurchase Agreements (Repos) Auction to be held on___________ by Reserve Bank of India

I/We* the undersigned hereby submit tender as set out below for the purchase ofGovernment of India dated securities/eligible Treasury Bills from you on__________________ with the undertaking that the same securities will be sold back toyou on ____________________________.

1 Name of the tenderer & Address

2 Amount bid @ (in figures)(in words) Rs. ________________ croreRupees ____________________ crore

3 Repo Rate percent per annuam (up totwo decimal points rounded off to thenearest 5 basis points)

4 Telephone No.

5 Fax No.

@ Indicates the nominal amount offered in Repo against securities.

Undertaking

On your acceptance of my/our* tender.

1. I/We* agree and undertake to immediately collect the Acceptance-cum-Deal confirmation advice from your office and to deposit the requisite amount atReserve Bank of India, Mumbai in the manner and on the day/time indicatedtherein.2. I/We* also authorize the Reserve Bank of India to be our custodian, tohold the securities purchased by us from Reserve Bank of India under the Repos,

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and to transfer them by debiting/crediting my/our Currenct Account and RepoConstituents Accounts based on our application/bid form.3. I/We* agree the beneficial interest, viz., Coupon, if any, in respect ofSecurities transferred by Reserve Bank of India to us and held in the RepoConstituents SGL Account will rest with Reserve Bank of India.

4. I/We* agree that the Reserve Bank of India shall not be held responsiblefor any loss, damage or liability on account of acting as the Custodian of oursecurities. I/We* also agree that I//We* shall indemnify and keep indemnified theReserve Bank of India at all times against any loss, damage or liability whatsoeverarising out of acting as Custodian of our securities as above.

I/We* have also submitted another bid(s)/not submitted any other bids* for the auction.

Terms and conditionsI/We* have read the terms and conditions for the auction and undertake to abide by them.

Yours faithfully,

i) Signature of official authorized to operateon SGL/Current Account _________________________

ii) Name _________________________iii) Designation _________________________ iv) Office stamp of the tenderer _________________________

* Strike out whichever is not applicable

Documents

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