Description
This is a presentation explaining about Issues of Liquidity Management; Receipt Payment Mismatch; Definition of Repo Reverse Repo; Theoretical Structure of LAF
MANAGEMENT OF LIQUIDITY – THE ISSUES
? ?
? ?
Managing mismatches between receipts and payments is at the heart of liquidity management Management of bank balance sheet ? Short to medium term maturity deposits ? Medium to long term maturity credit and investments People, firms, governments – mismatches in receipts and payments Users’ mismatches get shifted to the banking system ? What does the banking system do? ? Who deals with the mismatches and how? ? How do interest rates respond? ? Can large mismatches cause instability?
? These
are the central questions
RECEIPT PAYMENT MISMATCH
Companies and businesses – working capital arrangement ? Bank Overdraft ? Cash credit ? Bill discounting ? Short term loan from the market – private financers, NBFC ? Issue of short term paper – CP ? Supplier credit – pay after 90 days ? Chase customers for early payment – debtors ? Postpone payments to all vendors ? Some or all of these measures are used
?
LIQUIDITY MISMATCHES - OUTCOME
Attempt to deal with the receipts and payment mismatch Customer -------? Bank Bank ------? Inter- bank market All banks ----? RBI RBI ? ? If this transfer is not orderly, rule based, efficient and smooth ? Volatile interest rates ? Likely chaos ? System stability ?
?
LIQUIDITY MANAGEMENT – GOALS
Reduce excessive volatility in call market ? Interest rates ? Traded Volumes ? Reduce arbitrage opportunities ? Borrow from RBI and lend in call ? Create an avenue to absorb temporary surges in capital flows without causing significant disturbance in forex/money markets ? Bring a sense of order in transfer of liquidity mismatches from banks to the RBI
?
Liquidity Adjustment Facility (LAF) was considered appropriate solution ? Introduced in 2000, modified in a series of changes and stabilized in 2003
?
REPO/REVERSE REPO - DEFINITION
These terms refer to a class of trading contracts in the securities market ? These contracts generally involve fixed income securities, typically bonds and debentures ? A single contract has two legs (buy and sell) defined in the same contract ? Repo ? The seller of securities (bank) agrees to buy them back – repurchase – at a specified future time and at an agreed price from the counterparty (RBI) ? Reverse Repo ? The purchaser of securities (bank) agrees to sell them back to the seller (RBI) at specified time and price
?
REPO/REVERSE REPO - DEFINITION
In the specific context of the RBI conducting these auctions ? Repo results in injection of liquidity (Banks selling securities to repurchase later) ? Reverse repo results in absorption of liquidity (Banks buying securities to sell later) ? The volume in this market is constrained by ? Stock of securities available with RBI (if it desires to absorb liquidity) ? Stock of securities available with the banks (if banks desire additional liquidity)
?
LAF – THEORETICAL STRUCTURE
LAF is essentially a market mechanism ? Deals with liquidity mismatches in an orderly manner ? In this market the RBI is also a player - one with special status ? Sets the interest rates ? Sets the terms of trading ? Decides whether to accept or reject bids ? The overall market mechanism consists of an interest rate corridor and two markets ? One in which banks deal with the RBI (LAF) ? and the other in which the banks deal with each other (Call) ? LAF market is collateralized ? Call market is not – banks take clean exposure
?
LAF – THEORETICAL STRUCTURE
Interest Rate corridor ? Lower bound for parking surplus funds (Standing Deposit Rate) ? Upper bound for seeking additional funds (Refinance or marginal lending rate) ? Repo/reverse repo rates set in line with current market reality ? Call market to handle the spillovers/those players who do not have the collateral/ 0r ? Meet requirements after LAF window is closed ? Spread between Repo and R Repo ? Spread is a function of the condition of liquidity ? Generally 100-200 bp ? 300 bp spread (as it is now) is quite unusual
?
LAF – AS IN PRACTICE TODAY
There is no standing deposit rate – the legislation does not permit the RBI to accept clean deposits ? Refinance rate is set equal to Repo rate ? Effectively the interest rate corridor is defined by reverse repo rate as floor and repo rate as ceiling ? The stated stand of the RBI on LAF is as under ? RBI may choose options at its discretion
?
Overnight or longer term ? Fixed rate or variable rate (though not used in the last four years) ? One auction per day or more ? Variable tenor – one day repo seven day resverse repo ? Eligibility of securities
?
doc_857880150.ppt
This is a presentation explaining about Issues of Liquidity Management; Receipt Payment Mismatch; Definition of Repo Reverse Repo; Theoretical Structure of LAF
MANAGEMENT OF LIQUIDITY – THE ISSUES
? ?
? ?
Managing mismatches between receipts and payments is at the heart of liquidity management Management of bank balance sheet ? Short to medium term maturity deposits ? Medium to long term maturity credit and investments People, firms, governments – mismatches in receipts and payments Users’ mismatches get shifted to the banking system ? What does the banking system do? ? Who deals with the mismatches and how? ? How do interest rates respond? ? Can large mismatches cause instability?
? These
are the central questions
RECEIPT PAYMENT MISMATCH
Companies and businesses – working capital arrangement ? Bank Overdraft ? Cash credit ? Bill discounting ? Short term loan from the market – private financers, NBFC ? Issue of short term paper – CP ? Supplier credit – pay after 90 days ? Chase customers for early payment – debtors ? Postpone payments to all vendors ? Some or all of these measures are used
?
LIQUIDITY MISMATCHES - OUTCOME
Attempt to deal with the receipts and payment mismatch Customer -------? Bank Bank ------? Inter- bank market All banks ----? RBI RBI ? ? If this transfer is not orderly, rule based, efficient and smooth ? Volatile interest rates ? Likely chaos ? System stability ?
?
LIQUIDITY MANAGEMENT – GOALS
Reduce excessive volatility in call market ? Interest rates ? Traded Volumes ? Reduce arbitrage opportunities ? Borrow from RBI and lend in call ? Create an avenue to absorb temporary surges in capital flows without causing significant disturbance in forex/money markets ? Bring a sense of order in transfer of liquidity mismatches from banks to the RBI
?
Liquidity Adjustment Facility (LAF) was considered appropriate solution ? Introduced in 2000, modified in a series of changes and stabilized in 2003
?
REPO/REVERSE REPO - DEFINITION
These terms refer to a class of trading contracts in the securities market ? These contracts generally involve fixed income securities, typically bonds and debentures ? A single contract has two legs (buy and sell) defined in the same contract ? Repo ? The seller of securities (bank) agrees to buy them back – repurchase – at a specified future time and at an agreed price from the counterparty (RBI) ? Reverse Repo ? The purchaser of securities (bank) agrees to sell them back to the seller (RBI) at specified time and price
?
REPO/REVERSE REPO - DEFINITION
In the specific context of the RBI conducting these auctions ? Repo results in injection of liquidity (Banks selling securities to repurchase later) ? Reverse repo results in absorption of liquidity (Banks buying securities to sell later) ? The volume in this market is constrained by ? Stock of securities available with RBI (if it desires to absorb liquidity) ? Stock of securities available with the banks (if banks desire additional liquidity)
?
LAF – THEORETICAL STRUCTURE
LAF is essentially a market mechanism ? Deals with liquidity mismatches in an orderly manner ? In this market the RBI is also a player - one with special status ? Sets the interest rates ? Sets the terms of trading ? Decides whether to accept or reject bids ? The overall market mechanism consists of an interest rate corridor and two markets ? One in which banks deal with the RBI (LAF) ? and the other in which the banks deal with each other (Call) ? LAF market is collateralized ? Call market is not – banks take clean exposure
?
LAF – THEORETICAL STRUCTURE
Interest Rate corridor ? Lower bound for parking surplus funds (Standing Deposit Rate) ? Upper bound for seeking additional funds (Refinance or marginal lending rate) ? Repo/reverse repo rates set in line with current market reality ? Call market to handle the spillovers/those players who do not have the collateral/ 0r ? Meet requirements after LAF window is closed ? Spread between Repo and R Repo ? Spread is a function of the condition of liquidity ? Generally 100-200 bp ? 300 bp spread (as it is now) is quite unusual
?
LAF – AS IN PRACTICE TODAY
There is no standing deposit rate – the legislation does not permit the RBI to accept clean deposits ? Refinance rate is set equal to Repo rate ? Effectively the interest rate corridor is defined by reverse repo rate as floor and repo rate as ceiling ? The stated stand of the RBI on LAF is as under ? RBI may choose options at its discretion
?
Overnight or longer term ? Fixed rate or variable rate (though not used in the last four years) ? One auction per day or more ? Variable tenor – one day repo seven day resverse repo ? Eligibility of securities
?
doc_857880150.ppt