interest rates derivatives revisited…

so my favorite topic of interest rate swaps has made front page news today (in the Business Standard). apparently the food corporation of india (FCI) entered into a swap with Barclays in which FCI received fixed and paid an interest rate linked to the yield on Indian GSecs. now it so happens that reverse repo rates have gone up by much more than Barclays had projected (thus driving up yields on GSecs), and poor FCI is now getting mothered.

so the FCI goes crying to the RBI, so the RBI now wants ibanks to publish details of all the products they structure! and include the PnLs of derivatives transactions (which are off-balance sheet items) along with their financials. all in the hope that in the future government departments don’t get conned by scheming ibanks.

now i’m not sure how much of a protection the government agencies are going to get by this move. the deal in question is a vanilla interest rate swap, which apparently makes up for over 80% of all derivatives transactions worldwide. it is not a very tough product to understand, and it is unlikely the FCI man (or woman) handling the deal would have misunderstood it.

the problem, i believe lies in Barclays’ forecasts for Indian interest rates. in the absense of a vibrant bond trading market, and non-existance of interest rates futures and options markets, Barclays with its “experts” has had an upper hand over the unsuspeting FCI in terms of interest rates forecasts. and a convenient “conservative” twist to the forecasts has loaded the deal heavily in favor of Barclays!

disclosures are fine, but the need of the hour is to urgently open up Indian bond markets, including futures and options on interest rates. today’s business standard carries an editorial prescribing opening up of the bond markets on the same lines as the Indian stock markets, and these suggestions should be implemented by the RBI sooner rather than later.

a strong bond market would make interest rate futures publicly traded, and the markets would determine “consensus forecasts” of the rates, which could then be used to structure the swaps! This is the way things are done in major financial markets, and due to the bond markets there, you don’t find corporates or FIs cribbing to regulators about ibanks conning them regarding interest rate forecasts!

One thought on “interest rates derivatives revisited…”

  1. Two things:

    1. Why the “investment banking” tag? This & your ‘delta hedging” post – most real i-bankers (the way the term is used outside India) wouldn’t understand them. Just because IIMs and the local business press doesn’t understand teh various different types of finance roles? Is that how “i-banking”, the term, has come to mean anything an inv bank does? Money mangmt; sales; prop desks, etc? (The same tag for all your bail-out posts too?!)

    2. Basic point above re: Barclays was/is simpler than the one you make – they were paying fixed. Their downside was not dependent on any forecasts.

    3. But yes, corporate India (or in any part of the world) tends to do worse with any kind of forecasting of market variables. (Not that sell-side outfits, in absolute terms, are particularly good at it either – or anything other than riding bubbles or momentum, and selling garbage). Good point that.

    4. Why did FCI do this swap? Presumably, not because they were speculating – they must have thought they were hedging something else. Curious that other position does not appear here. Did not also not figure in said BusStd article?

    5. You are a trader, right? Aren’t you pleased if a bunch of sell-siders show you their positions? (What happened to the RBI proposal/demand?)

    Just curious!

    Nice blog – like your attention to cut through BS to get to the underlying funda.

Put Comment