Saturday, November 6, 2010

INBMK Swap...The Unique Animal

The INBMK swap of Indian markets is a unique animal. There is decent volume and interest in the product but over a period of time it has become a totally one-sided market with wide spreads (both bid-offer and spread to G-sec).   

A typical 10 yr INBMK [A fixed rate vs floating one year G-sec for a tenor of ten years] would get quoted today at say 7.45-7.75% if not wider as against the prevailing 10 yr G-sec yield of around 8% (semi-annual). 

Going by the fair value the swap should have been quoted around the 10 yr G-sec annualised rate, say something like 8.00-8.25.

I am told that this doesn't happen because firstly traders cannot short the underlying and hence when the typical receivers (usually PSU institutions and large corporates) receive, there is no way traders can hedge trading positions. Secondly, the quote drfits to the left, since some of these corporates donot mind receiving little lower levels in a composite deal including placement of their fixed rate NCDs. 

I feel that this can be changed by banks who have large SLR portfolio, by looking at the INBMK market and the SLR portfolio in a synergistic manner. Will not a sale from the SLR book for the required durations serve as a hedge? The typical answer to this has been that the SLR book is run by balance sheet desk while the Swap book is run by the trading desk. And unless banks with large SLR books (read nationalised banks) get into this market as traders, or unless perhaps the active traders start seeing much higher rates on the G-secs, this one-sided trending will continue. In any case, it is not appealing to common sense that a bank sitting on a large surplus of G-sec investments is reluctant to pay a lower fixed rate.  

Such a pity since the outstanding underlying is huge and banks do not view these spreads as gainful.  And an important link in credit spreads and corporate debt market remains strained.

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