Equipping the Indian banks in managing their asset liability better, the Bombay Stock Exchange (BSE), MCX Stock Exchange Ltd (MCX-SX) and National Stock Exchange (NSE) will be launching interest rate futures (IRFs), soon thereby acting as a central counterparties.
Sources close to the development said that in a meeting, held early this week, the RBI asked primary dealers to get ready for the launch of interest rate futures, by the stock exchanges in a month or two. ?RBI has asked us to gear up for the launch. We are now waiting for the clearance from the Sebi. This should happen in a month?s time,? said an industry source.
?Banks, primary dealers and financial institutions will use this product in a big way. A lot of companies today are not so happy with the way the pricing is done on the interest rate swaps and hence are looking at exchange traded IRFs,? said a dealer.
Last week, C B Bhave, chairman of Sebi said a joint committee of Sebi and RBI is looking at the introduction of interest rate futures and a report on the same is being finalised. Bhave also said that the committee is looking at allowing trading on currency options.
Interest rate futures are based on an underlying security which is a debt obligation and moves in value as interest rates change.
When interest rates move higher, the buyer of the futures contract will pay the seller an amount equal to that of the benefit received by investing at a higher rate versus that of the rate specified in the futures contract. Conversely, when interest rates move lower, the seller of the futures contract will compensate the buyer for the lower interest rate at the time of expiration.
Now, if a bank?s asset portfolio has an average duration longer than the average duration of its liabilities, IRS can be used to manage the bank?s balance sheet..
A rise in the market interest rate will cause the value of the bank?s assets to decline faster than the liabilities, reducing the bank?s net worth. In this instance also a short hedge in financial futures can be used.
If market interest rates have risen significantly, the interest cost of the bank?s borrowings will increase and the value of any fixed rate loans and securities held by the bank will decline. However, those losses will be approximately offset by a price gain on the futures contract. On the other hand, the bank can use a long hedge in futures when it has a negative duration gap and expects the interest rates to decline in the economy.