owned banks, with significant ownership in government bonds, aren’t relying as much on the derivatives market to hedge domestic interest rate risks amid increasingly evident signs Mint Road would largely be decoupled from global peers while finalising its rate calls.
The market share of nationalised banks in the Interest Rate Swap (IRS) MIBOR segment dropped to a mere 1.66% in April 2024 from a high of 7.56% in March 2023, the latest data published by the Clearing Corporation of India (CCIL) showed.
State-owned banks have traditionally shied away from the IRS MIBOR, or Overnight Index Swap (OIS) market, which is heavily dominated by foreign banks. An analysis of the data shows, however, that nationalised banks had shed some of that reluctance two years ago, with their market share consistently staying above the 4% level from June 2022 to July 2023.
At its height in March 2023, the market share of 7.56% for nationalised banks translated into a total notional amount of trades worth ₹1.24 lakh crore. In April 2024, that figure was at ₹20,315 crore.
The decline in market share that started from August 2023, coincides with a period in which liquidity in the banking system dried up significantly, leading to a sharp rise in short-term market rates.
Short-Term Rates Climb
“While there was a fair bit of expectations of rate cuts in 2024, short-term rates had spiked owing to sustained tightness in the system liquidity. Moreover, banks witnessed strong credit demand and unfavourable credit-deposit ratios. All these things seem to have curtailed activities in the swap market,” said Soumyajit Niyogi, director at India Ratings & Research.
From August 2023 to January 2024, banking system liquidity was consistently in deficit mode, with the overnight call money rate hovering around 20-25 basis points higher than the repo rate. Consequently, the MIBOR, which is derived from the call rate, also shot up, leading to some market participants suffering losses on OIS positions that did not predict the sharp rise in money market rates, traders said.
The MIBOR – the Mumbai Interbank Outright Rate – is the floating rate used in this type of IRS instrument. OIS is a method of hedging interest rate risk emanating from exposure in the government bond market – by taking an opposite position.
Indian banks mandatorily hold government securities as a part of the Statutory Liquidity Ratio (SLR), which calls for lenders to park a portion of their deposits in sovereign bonds. Given that nationalised banks have large deposit bases, their holdings of government bonds are also correspondingly large.
In an OIS trade, one entity receives fixed rates on the expectation that interest rates could decline while another entity pays fixed rates on the anticipation of interest rates declining.
Another factor that has likely played a part in the declining market share of state-owned banks is the significant volatility that has occurred in US bond markets over the past year due to the repricing of rate cut expectations by the Fed. Movements in US bond yields exert a major influence on the domestic OIS market as banks – mainly foreign lenders – take positions in the local market to hedge their exposure to offshore clients.
Further, the Reserve Bank of India’s unequivocal aim of bringing consumer price inflation down to 4% has also clouded visibility on domestic rate cuts as the price gauge remains above that mark.
