CBLO - A MONEY MARKET INSTRUMENT

A PROJECT ON MONEY MARKET INSTRUMENT COLLATERALISED BORROWING & LENDING OBLIGATION

Contents 1) AN INTRODUCTION TO MONEY MARKET 2) INTRODUCTION TO CBLO 3) INTRODUCTION TO CCIL 4) PARTICIPANTS 5) WORKING OF CBLO 6) LOOPHOLES IN THE MARKET 7) EXEMPTIONS & PROVISIONS 8) ADVANTAGES OF CBLO 9) CBLO – PROPOSED TO BE USED AS A BENCHMARK RATE 10)CBLO GENERATES ARBITRAGE OPPORTUNITIES 11)CBLO AND MANAGEMENT OF RISK

THE MONEY MARKET The money market is the market for financial assets that are close substitutes of money .It is a market for short-term funds and instruments having a maturity period of one or less than one year.It is not a single market but a collection of markets for several instruments.It is a need based market where demand and supply of money shape the market. Thus , a money market provides a balancing mechanism to even out the demand for and supply of short term funds. An efficient money market provides liquidity . Perhaps the biggest advantage and the most attractive feature of the money market is liquidity.. This means that if an investor wants to liquidate a money market position, he or she will have very little trouble turning the funds into cash. Money market provides a stable source of funds to banks and encourages the development of non bank intermediaries . MONEY MARKET INSTRUMENTS : Treasury bills Call money market Commercial papers Certificates of deposits Commercial bills COLLATERALISED LENDING AND BORROWING OBLIGATIONS

COLLATERALISED BORROWING AND LENDING OBLIGATION (CBLO) RBI, in its Mid-Term Review of Monetary and Credit Policy for the year 2002-03, announced the introduction of "Collateralised Borrowing and Lending Obligation (CBLO)", a product developed by CCIL, as a money market instrument and subsequently issued detailed operative guidelines for the product. CBLO is a discounted instrument issued in electronic book entry form for the maturity period ranging from one day to one year. CCIL provides a dealing platform through which market participants can borrow and lend funds. COLLATERALISED BORROWING & LENDING OBLIGATION It is an obligation by the borrower to return the money borrowed, at a specified future date and authority to the lender to receive money lent, at a specified future date with an option/privilege to transfer the authority to another person for value received INTRODUCTION OF CCIL The Clearing Corporation of India Ltd. (CCIL) was set up in April, 2001 for providing exclusive clearing and settlement for transactions in Money, GSecs and Foreign Exchange. The prime objective has been to improve efficiency in the transaction settlement process, insulate the financial system. The Clearing Corporation of India Ltd. (CCIL), the clearing agency, operates a market for CBLOs—a form of tripartite repo (approved by the RBI) that allows market participants to create borrowing facilities by placing collateral securities (government bonds and treasury bills) at the CCIL. Borrowers can then bid for funds (up to their collateral’s value less a discount margin) through the CBLO system—a transparent, electronic order book. CBLOs are an innovative technique unique to India, developed to supplement and possibly supplant the bilateral repo

market. Established in 2001, CCIL is India's first exclusive clearing and settlement institution to provide guaranteed settlement facility for transactions in government securities, money market instruments, and foreign exchange. PARTICIPANTS : Initially the membership of cblo segment was extended to banks , primary dealers , mutual funds, financial institutions and insurance companies that are the members of negotiated dealing system .The range of the participants has been widening overtime. By January 2004 , the non NDS members like corporates , cooperative banks, non bank financial companies , pension funds and trusts are also eligible to borrow and lend in the CBLO market. WORKING OF CBLO : OPEN CONSTITUENT SUBSIDIARY GENERAL LEDGER ACCOUNT (CSGL)

CLEARING AND SETTLEMENT BY CLEARING CORPORATION OF INDIA

FIXATION OF THE BORROWING LIMIT OF MEMBERS

SELECTION OF THE BEST BID AND BEST OFFER

DEPOSITION OF THE CASH BY THE BORROWERS & LENDERS

INDICATION OF THE REQUIREMENT (AMOUNT , MATURITY, OFFER RATE & BID RATE)

The borrowing members are required to open CSGL account with ccil for depositing securities which are offered as collateral for borrowing and lending funds .The borrowing limits of each member is fixed based on the market value of the securities deposited in CSGL account . A possible fall in the prices of securities is factored into the value of securities to decide the borrowing limit.Thus borrowers can avail funds upto the extent of market value of securities offered as collateral .

The borrowing limit for the members is fixed daily at the beginning of the day taking into account the securities deposited by them in the CSGL account . Lenders in the Auction market and both borrowers and lenders in the Normal market are required to deposit initial margin in the form of cash. The cblo is an obligation by the borrower to return the borrowed money at a specified future date and an authority to the lender to receive money lent with an option or privilege to transfer authority to another person for value received. CBLO is a discounted instrument issued in an electronic book entry form . Both the borrowers and lenders indicate their requirement which includes the amount , maturity and the rate at which they want to lend or the offer rate that is proposed by the borrower and the bid rate proposed by the lender. The rate of interest depends upon the demand and supply of money in the market . The rate of interest is less than the call money as it is secured. Hence each lender and borrower independently enters their requirements into the online trading system . The best offer is the highest rate at which the borrower is willing to borrow and the best bid at which the lender is willing to lend appears on the screen . AUCTION MARKET

In auction market , the platform provided by the ccil the borrowers submit their offers and the lenders will give their bids specifying the discount rate and the maturity period .The bids and offers will be through an auction screen , which will be open from 9.45 a.m. to 1.30 p.m. on every working day .

NORMAL MARKET The members can use the Normal market for trading in CBLOs, to sell the CBLOs in their account to meet their funds requirement instead of waiting till maturity. Such members submit selling offers indicating the amount and rate. Like-wise, members intending to buy CBLOs (lend funds) submit their bids specifying the amount and rate for a particular CBLO. The matching of bids and offers takes place. Normal market session is open from 9.00 A.M. to 3.30 P.M. on weekdays except Saturday i.e. from 9.00 A.M. to 1.30 P.M. CCIL accepts the borrowing requests and places the borrowing amount on the specified auction windows. The lenders willing to lend submit their bids directly on the auction window indicating the amount and the rate during the auction session which is open from 11.15 A.M. to 12.15 P.M. The lenders have the flexibility to modify/cancel their bids during the auction session while borrowers are not permitted to revise/cancel their offers. The successful borrowers and lenders are notified regarding borrowing and lending of funds by them through the negotiated dealing system and the lenders who hold CBLOs are permitted to trade in CBLOs in the Normal market from the subsequent day onwards. After the trading session, all the matched deals of both the Auction and Normal markets are taken up for processing and settlement . The settlement is on T+0 basis. CCIL assumes the role of the central counter party and guarantees settlement of transactions . CCIL debits the members' CBLO accounts / borrowing limit to the extent of their final CBLO payable obligations. The securities are blocked in the CSGL account to the extent of borrowing till the redemption of CBLO. There will be no transfer of securities to the lenders but lenders interest in the underlying securities is recognized through documentation. Then, the funds obligation for each member is netted across all the matched deals of the concerned member in

the Auction and Normal market. The net funds obligation comprising the member-wise payable and receivable position is sent electronically to RBI for effecting debits and credits in the members' current accounts through the settlement account of CCIL with RBI. After effecting funds transfer between members' current accounts, RBI sends funds settlement confirmation to CCIL. After receiving confirmation of fund settlement from RBI, CCIL will credit CBLOs to the respective buyer member's CBLO account. LOOPHOLES IN THE MARKET The shortage of funds can take place from both the sides i.e. either the lender doesn’t meet the obligation on the day of trade or the borrower fails to meet the obligation on redemption at the time of maturity. In both the cases ccil acts as a counter party and completes the settlement . When the borrower defaults , then the underlying securities are not released to the borrower till the funds are replenished . Thus it liquidates the securities and adjusts the proceeds towards the shortfall . CCIL minimises risk relating to transaction and settlement by adopting strict membership norms . It restricts membership only to those entities that meet the minimum eligibility criteria .They can borrow amount equivalent to the market value of securities deposited in the CSGL account.

EXEMPTIONS & PROVISIONS : CRR : For the development of cblo as a money market instrument , RBI has given a special exemption from CRR for transactions in CBLO subject to condition that the bank maintains a minimum CRR of 3%. SLR : Unencumbered securities in the CSGL account can be taken by the concerned bank for the SLR purpose by the concerned bank at the end of each day.

COLLATERALS : The title / ownership of the securities remain with the borrowing members and they are not transferred to the lenders. ADVANTAGES OF CBLO: CBLO’S offer a number of advantages to the Indian market: 1) Access is open to a wider range of participants than the conventional interbank market . CBLO participants include domestic and foreign banks , mutual funds , provident funds , insurance companies and primary dealers . The main requirement on participants are that they have a CSGL account. 2) CCIL conducts risk management and is able to gurantee transactions- in fact , the number of failures has been very small . 3)The RBI grants exemptions from following cash reserve ratio and SLR requirements to encourage the development of the market. 4)An important advantage of CBLO over repos is that the instrument is tradable , allowing a borrower to reserve the position and repay before the term expires and CBLO are secure because the involvement of CCIL as gurantor of each transaction . 5)The screen based trading provides transparency and maintains anonymity of counter parties that is presently lacking in the money market operations. 6)Since CBLO operates for a longer period than the call market there is an easy access to funds.For eg. If a bank suddenly comes to know that it has to make an advance and the operation time of call market is over then the bank can resort to CBLO for funds . Thus , we see that CBLO is an alternative to call money, allowing participants to borrow and lend funds against securities , volume of trade in the former is constantly growing with time .

CBLO –PROPOSED TO BE USED AS A BENCHMARK RATE

Given the quantum rise in the volumes of the collateralised borrowing and lending obligations (CBLO) market, clearing agency Clearing Corporation of India Ltd (CCIL) has proposed) to examine the feasibility of using CBLO bid/offer rates as the benchmark for the interest rate swap and the credit market In the recent months, the trading volume in the CBLO segment has been higher than the combined trading volume of the overnight call and market repo.

Activity in Money Market Segments(in rupees crores) Year/ Month(1)

Call (2)

Market Repo(3)

CBLO (4)

Total (2 to 4)

Apr-09

10,910

20,545

43,958

75,413

May-09

9,518

22,449

48,505

80,472

Jun-09

8,960

21,694

53,553

84,207

Jul-09

7,197

20,254

46,501

73,952

Aug-09

7,569

23,305

57,099

87,973

Sep-09

8,059

27,978

62,388

98,425

Oct-09

7,888

23,444

58,313

89,645

Nov-09

6,758

22,529

54,875

84,162

Dec-09

6,651

20,500

55,338

82,489

Jan-10

6,411

14,565

50,571

71,547

Feb-10

6,809

19,821

63,645

90,275

Mar-10

8,812

19,150

60,006

87,968

Apr-10

8,187

20,319

50,891

79,397

May-10

8,393

17,610

42,274

68,277

CBLO: Collateralised Borrowing and Lending Obligation SOURCE : RBI REPORT ON FINANCIAL MARKETS

However, the call money market is accessible only to the banking sector and is not available to the mutual fund players and the insurance companies and hence they deploy a sizable proportion of their surplus cash in the CBLO market The CBLO has all the following characteristics that a benchmark rate must possess: 1) Liquidity : Good liquidity is the fundamental requirement for a benchmark instrument and the same is measured in terms of turnover in that instrument . The liquidity in CBLO market is high .

2) Accessibility: The market is not restricted to any particular segment and it is open to all categories that are banks financial institutions, primary dealers insurance companies, mutual funds co-operative banks, corporates provident funds etc

3) Transparency: CBLO trades are executed on an anonymous, electronic order driven matching system which disseminates market statistics on-line thus ensuring high transparency in transactions.

4) Acceptability: CBLO product is approved by RBI as money market instrument and the product is also approved by Insurance Regulatory authority. Ministry of Finance has also allowed investment in CBLOs by non governmental provident funds. The CBLO market commands wide acceptability among Indian money market participants which is reflected in its high volume.

5) Availability for different tenors: CBLO maturities are available for various tenors ranging from overnight up to ninety days. RBI has allowed the maturity of CBLO upto one year.

6) Credit Risk: In fact there is no credit risk available in CBLO market as all the transactions are backed by collaterals in the form of market value of securities and Cash Settlement of all the trades in CBLO . Market is fully guaranteed by the Clearing Corporation of India Limited (CCIL) and hence the market is devoid of counter party risk.

7)Online Data : The CBLO market data are available on-line which can be readily used without any lead/lag effect instrument in compiling data.

All the above factors contribute in accepting cblo as a benchmark rate. CBLO GENERATES ARBITRAGE OPPORTUNITIES Banks, particularly Government owned, are borrowing against their surplus holding of government securities at a lower rate under Clearing Corporation’s Collateralised Borrowing and Lending Obligation (CBLO) mechanism and deploying the funds at a higher rate with RBI. The rate differentials existing between these two markets provide scope for arbitragers . At times banks have surplus securities i.e. even after meeting slr requirements , it still has some unencumbered securities in possession . The banks can use these securities to borrow from the cblo market having lower interest rate and lend to a market having higher interest rate.Thus , the bank earns arbitrage profit equal to the difference between the two interest rate . If the bank borrows Rs. 130 crores at 4.9% and lends the amount at 5.6% in a day then he earns a profit of 70 basis points. Consider if a bank had borrowed on Monday against its surplus securities holding at 2.72 per cent under CBLO and lend the funds at RBI’s Reverse Repo (R/R) at 3.25 per cent, it stands to make a gain of 53 basis points (100 basis points equals 1 per cent) in just a day.

There has been an increasing shift towards borrowing in the CBLO market . The trading advantages of the CBLO system has increased the acceptability and attractiveness of CBLO

Source: RBI , Money Market Operations The above graph shows the cblo rates at a lower rate than call and repo rates.

CBLO AND MANAGEMENT OF RISK CCIL's risk exposure in the CBLO segment arises becauses of two reasons :- Firstly due to Risk of default by a borrower in repayment on maturity of a CBLO and secondly because of risk of failure by a lender to meet its obligations to make funds available to a borrower . As the repayment of borrowing under CBLO is guaranteed by CCIL, it should have enough security to meet any eventuality of a default by the borrower. To take care of this risk, all borrowings are fully collateralised. Thus all the CBLO members have to maintain collateral or cash margin with the ccil as cover for the borrowing and lending. A member may undertake to either lend or borrow but may fail to honour such an obligation at the time of settlement .

As CCIL extends guarantee for settlement of all CBLO transactions, to ensure that this risk is adequately taken care of, CCIL collects Initial Margin from the member in respect of its deals. As the risk for any such deal would continue up to the settlement of the deal, Initial Margin collected on deals is released on settlement of such deals.

CONCLUSION: The CBLO has emerged as a preferred market since it offers anonymity to market participants and provides funds at lower cost . The cooperative banks , public and private sector banks are large borrowers in the market on account of favorable borrowing cost . The daily average volumes increased from Rs. 2,506 crores in march 2004 to Rs, 42,274crores in may 2010. Thus , the CBLO market has grown phenomenally by encouraging a greater range of market participants and providing tremendous flexibility to the user.

BIBLIOGRAPHY : www.ccil.com

www. Financial express.com www.rbi.com