A good read on liquidity risk measures and latest BCBS guide lines for liquidity risk management.
Saturday, May 31, 2014
Liquidity and VaR
Lot of focus has been shifted on liquidity risk management. Basel committee also planning to recommended that holding period of VaR calculation should be based on asset classes and time required to unwind the positions. It is understood that liquidity affects risk management because if markets are not liquid than it will take more time to unwind the positions. Interestingly risk management also affects the liquidity. Tighter risk management reduces liquidity, which in turn leads to tighter risk management, etc. This can help explain sudden drops in liquidity and, since liquidity is priced, in prices in connection with increased volatility or decreased risk-bearing capacity. This paper provides a model of the interaction between risk-management practices and market liquidity.
Sunday, May 18, 2014
Indian Money market instruments - Repo & Call
Repurchase Agreement (Repo) is an instrument for borrowing funds by selling securities with an agreement to repurchase the said securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed.
The reverse of the repo transaction is called ‘reverse repo’ which is lending of funds against buying of securities with an agreement to resell the said securities on a mutually agreed future date at an agreed price which includes interest for the funds lent.
RBI has permitted select entities (scheduled commercial banks excluding RRBs and LABs, PDs, all-India FIs, NBFCs, mutual funds, housing finance companies, insurance companies) to undertake repo in both the repo market.
The reverse of the repo transaction is called ‘reverse repo’ which is lending of funds against buying of securities with an agreement to resell the said securities on a mutually agreed future date at an agreed price which includes interest for the funds lent.
It can be seen from the definition above that there are two legs to the same transaction in a repo/ reverse repo. The duration between the two legs is called the ‘repo period’. Predominantly, repos are undertaken on overnight basis. Settlement of repo transactions happens along with the outright trades in government securities. Repo that are not overnight termed as Term Repo.
Earlier repo securities in corporate debt allowed except CPs, CDs and NCDs maturing in less than one year. But from Jan 2013 RBI also permitted repo these securities. Only listed corporate debt securities that AA or above rated are eligible to be used for repo.
However volume in "Repo in corporate debt" is very less. This can be due to sharp haircut ,10% -12%-15%, while in CBLO haircuts are 5%. Also in "Repo in corporate debt" market pricing is not based on online platform but lender needs to find out the borrower while in CBLO market pricing is determined through online ask - bid spreads.
Call/Notice/Term Money -
The call/notice/term money market is a market for trading very short term liquid financial assets that are readily convertible into cash at low cost. The money market primarily facilitates lending and borrowing of funds between banks and entities like Primary Dealers. An institution which has surplus funds may lend them on an uncollateralized basis to an institution which is short of funds.
The period of lending may be for a period of 1 day which is known as call money and between 2 days and 14 days which is known as notice money. Term money refers to borrowing/lending of funds for a period exceeding 14 days. The interest rates on such funds depends on the surplus funds available with lenders and the demand for the same which remains volatile.
This market is governed by the Reserve Bank of India which issues guidelines for the various participants in the call/notice money market. The entities permitted to participate both as lender and borrower in the call/notice money market are Scheduled Commercial Banks (excluding RRBs), Co-operative Banks other than Land Development Banks and Primary Dealers.
Scheduled commercial banks are permitted to borrow to the extent of 125% of their capital funds in the call/notice money market, however their fortnightly average borrowing outstanding should not exceed more than 100% of their capital funds (Tier I and Tier II capital). At the same time SCBs can lend to the extent of 50% of their capital funds on any day, during a fortnight but average fortnightly outstanding lending should not exceed 25 per cent of their capital funds.
Co-operative Banks are permitted to borrow upto 2% of their aggregate deposits as end of March of the previous financial year in the call/notice money market.
Primary Dealers can borrow on average in a reporting fortnight up to 225% of the total net owned funds (NOF) as at end-March of the previous financial year and lend on average in a reporting fortnight up to 25% of their NOF.
The trades are conducted both on telephone as well as on the NDS Call system, which is an electronic screen based system set up by the RBI for negotiating money market deals between entities permitted to operate in the money market. The settlement of money market deals is by electronic funds transfer on the Real Time Gross Settlement (RTGS) system operated by the RBI. The repayment of the borrowed money also takes place through the RTGS system on the due date of repayment.
This market is governed by the Reserve Bank of India which issues guidelines for the various participants in the call/notice money market. The entities permitted to participate both as lender and borrower in the call/notice money market are Scheduled Commercial Banks (excluding RRBs), Co-operative Banks other than Land Development Banks and Primary Dealers.
Scheduled commercial banks are permitted to borrow to the extent of 125% of their capital funds in the call/notice money market, however their fortnightly average borrowing outstanding should not exceed more than 100% of their capital funds (Tier I and Tier II capital). At the same time SCBs can lend to the extent of 50% of their capital funds on any day, during a fortnight but average fortnightly outstanding lending should not exceed 25 per cent of their capital funds.
Co-operative Banks are permitted to borrow upto 2% of their aggregate deposits as end of March of the previous financial year in the call/notice money market.
Primary Dealers can borrow on average in a reporting fortnight up to 225% of the total net owned funds (NOF) as at end-March of the previous financial year and lend on average in a reporting fortnight up to 25% of their NOF.
The trades are conducted both on telephone as well as on the NDS Call system, which is an electronic screen based system set up by the RBI for negotiating money market deals between entities permitted to operate in the money market. The settlement of money market deals is by electronic funds transfer on the Real Time Gross Settlement (RTGS) system operated by the RBI. The repayment of the borrowed money also takes place through the RTGS system on the due date of repayment.
Arbitrage b/w CBLO and repo market
There can be arbitrage opportunity for market participants who have access of both the markets. If repo rate is less than CBLO rate than banks or PDs can borrow in repo market and lend that money in CBLO market for almost risk free return.
If CBLO rate is less than reverse repo rate than banks can borrow in CBLO market and park that money with RBI at reverse repo rate for risk free return.
So for no arbitrage CBLO rate should be in between of repo and reverse repo rate. Now reverse repo rate is always 100 basis point less than repo rate.
Saturday, May 17, 2014
Indian Money market instruments -CBLO
Collateralised borrowing and lending obligation (CBLO) is another money market instrument operated by the Clearing Corporation of India Ltd. (CCIL), for the benefit of the entities who have either no access to the inter bank call money market or have restricted access in terms of ceiling on call borrowing and lending transactions. CBLO is a discounted instrument available for the maturity period ranging from one day to ninety days (up to one year as per RBI guidelines).
Different types of CBLO
In order to enable the market participants to borrow and lend funds, CCIL provides the Dealing System through Indian Financial Network (INFINET), a closed user group to the Members of the Negotiated Dealing System (NDS) who maintain Current account with RBI and through Internet for other entities who do not maintain Current account with RBI.
CCIL becomes Central Counterparty to all CBLO trades and guarantees settlement of CBLO trades.
Membership to the CBLO segment is extended to entities who are RBI- NDS members, viz., Nationalized Banks, Private Banks, Foreign Banks, Co-operative Banks, Financial Institutions, Insurance Companies, Mutual Funds, Primary Dealers, etc. Associate Membership to CBLO segment is extended to entities who are not members of RBI- NDS, viz., Co-operative Banks, Mutual Funds, Insurance companies, NBFCs, Corporates, Provident/ Pension Funds, etc.
By participating in the CBLO market, CCIL members can borrow or lend funds against the collateral of eligible securities. Eligible securities are Central Government securities including Treasury Bills, and such other securities as specified by CCIL from time to time. Borrowers in CBLO have to deposit the required amount of eligible securities with the CCIL based on which CCIL fixes the borrowing limits. CCIL matches the borrowing and lending orders submitted by the members and notifies them. While the securities held as collateral are in custody of the CCIL, the beneficial interest of the lender on the securities is recognized through proper documentation.
CCIL becomes Central Counterparty to all CBLO trades and guarantees settlement of CBLO trades.
Membership to the CBLO segment is extended to entities who are RBI- NDS members, viz., Nationalized Banks, Private Banks, Foreign Banks, Co-operative Banks, Financial Institutions, Insurance Companies, Mutual Funds, Primary Dealers, etc. Associate Membership to CBLO segment is extended to entities who are not members of RBI- NDS, viz., Co-operative Banks, Mutual Funds, Insurance companies, NBFCs, Corporates, Provident/ Pension Funds, etc.
By participating in the CBLO market, CCIL members can borrow or lend funds against the collateral of eligible securities. Eligible securities are Central Government securities including Treasury Bills, and such other securities as specified by CCIL from time to time. Borrowers in CBLO have to deposit the required amount of eligible securities with the CCIL based on which CCIL fixes the borrowing limits. CCIL matches the borrowing and lending orders submitted by the members and notifies them. While the securities held as collateral are in custody of the CCIL, the beneficial interest of the lender on the securities is recognized through proper documentation.
CBLO Normal Market - It facilitates borrowing and lending by members on an online basis.
CBLO Auction Market - It facilitates borrowing and lending by members through submission of bids and offers.
CBLO features
Central Government Securities including Treasury Bills as specified by CCIL.
CBLO features
- This RBI approved Money Market instrument is backed by Gilts as collateral.
- It creates an obligation to repay the borrowed money along with interest on a fixed date. Also it provides a right to the lender to receive money lent with interest on a fixed future date.
- CBLO is tradable and CCIL acts counterparty to transaction.
- It is traded on screen that provides right amount of anonymity to a trade for counter parties.
Central Government Securities including Treasury Bills as specified by CCIL.
ECB dilemma on monetary policy and QE
Investors bought peripheral government bond in anticipation of QE program, asset purchase program, will be initiated by European central bank (ECB). However latest Europe economy data has shown that economy has expanded by just 0.2% lead by 0.8% Germany expansion.
Many investors now expects that ECB to lower the interest rate and launch the long term refinancing operations (LTRO) rather than starting an asset purchase scheme at its June meeting, Euro slips as periphery bond yields rise.
Many investors now expects that ECB to lower the interest rate and launch the long term refinancing operations (LTRO) rather than starting an asset purchase scheme at its June meeting, Euro slips as periphery bond yields rise.
These speculations prompted a sell-off this week in peripheral bond markets, sending yields higher. ECB already has zero deposit rates and inflation around 0.7% that is less than half of its 2%long run target. Top short term priority of ECB is to avoid deflation, ECB: An appropriate monetary policy.
Friday, May 16, 2014
Why traders should take interest in football worldcup
I read a interesting article on FT, Why bond traders should watch World Cup . Some of the points that Ralph are making-
1) There will be millions of online betting transactions conducted by football fans. This can be a good laboratory for testing how human market function. It has also been researched that human run market can be very efficient.
2) It is safe to assume that all betters will have all information at same time so there will not be any information asymmetry once match starts. Odds change during a match; the nearer the final whistle, the more predictable the result.
In India online betting is not legal so I can't be the one of the learner from this huge opportunity.
1) There will be millions of online betting transactions conducted by football fans. This can be a good laboratory for testing how human market function. It has also been researched that human run market can be very efficient.
2) It is safe to assume that all betters will have all information at same time so there will not be any information asymmetry once match starts. Odds change during a match; the nearer the final whistle, the more predictable the result.
In India online betting is not legal so I can't be the one of the learner from this huge opportunity.
Banking book & Trading book
"Book" in banking is very widely used term. Book is nothing but smallest trades organizing entity that holds some particular trades. Books gets created based on different criteria such as trader, accounting treatment, risk methodology treatment , legal entity and etc. All books are normally arranged in hierarchy.
Classification of banking book and trading book is very important for risk and accounting treatment. BCBS committee guidelines have different risk computation treatment for banking and trading book.
Trading book should contains all trades that are traded with intent of making profit through market price movement, hold for short term resale, lock in arbitrage profit or to hedge other trading book positions. Trading books needs to be valued at fair value daily, mark to market daily.Under BCBS guidelines capital charge for trading book gets calculated using VaR, SVaR and IRC.The value-at-risk for assets in the trading book is calculated at a 99% confidence level based on a 10-day time horizon.
Banking book should contains all positions that have been taken with intent of holding them till m
aturity. Banking books does not need to be valued at fair value daily, no mark to market daily. Assets can be on balance sheet at their historic values. Capital charge for banking book gets calculated from RWA (risk weighted assets).The value-at-risk for assets in the banking book are calculated at a 99.9% confidence level on a one-year horizon.
Currently there are no specific rules are defined to classify trades into banking and trading books. It has been left to banks to decide the intent of trading and classify the trade accordingly. Until Basel 2 guidelines there was a huge capital advantage in keeping trade in trading book instead of banking book. It is like shifting the banking book loan to trading book bond and reducing capital. But after IRC requirement in Basel 2.5 guidelines it has come significantly down. A detailed comparison of baking book and trading book capital charges are compared using one sample portfolio in Swing Basel document.
BCBS is reviewing the trading book framework. It has released updated consultative document on the same, Fundamental review of the trading book.
Before BCBS come with defined rules for banking book and trading book boundary, currently different banks have setup their on policy to do the same. On larger view below methodology gets followed to classify the book as banking and trading.
Classification of banking book and trading book is very important for risk and accounting treatment. BCBS committee guidelines have different risk computation treatment for banking and trading book.
Trading book should contains all trades that are traded with intent of making profit through market price movement, hold for short term resale, lock in arbitrage profit or to hedge other trading book positions. Trading books needs to be valued at fair value daily, mark to market daily.Under BCBS guidelines capital charge for trading book gets calculated using VaR, SVaR and IRC.The value-at-risk for assets in the trading book is calculated at a 99% confidence level based on a 10-day time horizon.
Banking book should contains all positions that have been taken with intent of holding them till m
Currently there are no specific rules are defined to classify trades into banking and trading books. It has been left to banks to decide the intent of trading and classify the trade accordingly. Until Basel 2 guidelines there was a huge capital advantage in keeping trade in trading book instead of banking book. It is like shifting the banking book loan to trading book bond and reducing capital. But after IRC requirement in Basel 2.5 guidelines it has come significantly down. A detailed comparison of baking book and trading book capital charges are compared using one sample portfolio in Swing Basel document.
BCBS is reviewing the trading book framework. It has released updated consultative document on the same, Fundamental review of the trading book.
Before BCBS come with defined rules for banking book and trading book boundary, currently different banks have setup their on policy to do the same. On larger view below methodology gets followed to classify the book as banking and trading.
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Banking Book or Trading Book decision |
Tuesday, May 13, 2014
Ireland's borrowing cost
Good reads on what is latest on euro zone crisis. After four year of Greece bailout, Ireland’s ten year borrowing costs dropped below the UK’s.
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