PSU banks: PSU banks raising stakes in interest rate derivatives to diversify risk management

Mumbai: The Reserve Bank of India has often exhorted banks to utilise the domestic derivatives infrastructure to mitigate risk from their government bond positions. The largest bondholders in the banking pack are taking heed.

The establishment of a derivatives trading platform by the Clearing Corporation of India (CCIL) in 2015 has played a large role in bringing hitherto reluctant public sector banks into the trading fold for derivatives. A broad push towards defter management of interest rate risk too contributed.

From a market share of just 0.2% in February 2015, nationalised banks accounted for 7.6% of overall trades in MIBOR (Mumbai Interbank Outright Rate) interest rate swaps (IRS) in March 2023, CCIL data showed. The notional amount of state-owned banks in IRS trades was at ₹1.2 lakh crore in March 2023, more than a hundred times higher than ₹875 crore in February 2015.

The MIBOR IRS includes Overnight Indexed Swaps (OIS) which are amongst the most liquid interest rate derivatives markets in India. The RBI introduced IRS in 1999. In an OIS trade, one entity agrees to pay another a fixed interest rate in exchange for a floating rate, which is the MIBOR.

Given that Indian banks mandatorily hold large amounts of government bonds, mitigating interest rate risk stemming from the debt exposure assumes importance. OIS is the principal tool for hedging interest rate risk.

THE CCIL PLATFORM
State-owned banks had traditionally shied away from OIS, partly because the market was heavily swayed by overseas investment calls which were primarily driven by an asymmetric flow of information.

In August 2015, the CCIL launched ASTROID, an anonymous IRS dealing system. Many herald the platform as the key structural factor in bringing more players to the fold.

“The earlier impression amongst many banks was that the information mismatch was too large, foreign banks had exclusive access to overseas client flows and the OIS product was not as liquid as government bonds,” Naveen Singh, head of trading at ICICI Securities Primary Dealership said. “With ASTROID, there is a CCIL guarantee, and the anonymous platform gives you confidence. Price discovery is better, and information gets priced onto the screen much more democratically,” he said.

BOND-SWAP ARBITRAGE
Treasury executives from PSU banks said that at the current juncture, a lucrative arbitrage opportunity between government bond yields and OIS rates was driving trading interest.

“The five-year government bond yield is currently near 7%, while the five-year OIS is 100 basis points lower. Nowhere else in the world will you find an interest rate spread so much lower than the cash spread,” a general manager at a state-owned bank said. “The MIBOR is also higher than long-term rates so by simply doing an OIS transaction we are enjoying a large carry. The only issue is that for OIS exposure, a bond has to be kept in the held-for-trade portfolio which must be liquidated within 90 days,” he said.

FOREIGN BANKS, DEEPER MARKETS
While foreign banks continue to dominate derivatives trading, their market share has gone down from 75.9% in February 2015 to 57.1% in March 2023. The data excludes US banks which do not trade OIS on ASTROID due to regulatory differences in the treatment of counterparties.

“The liberalisation of OIS which happened in early 2019, where banks were allowed to provide it to non-Indian counterparties. That’s where private banks and nationalised banks to some extent, have taken a big leap and hence the foreign bank share has gone down,” said Nitin Agarwal, head of trading at ANZ.