Why fixed deposits are likely to give better returns after RBI's rate hike

Repo (Repurchase) rate also known as the benchmark interest rate is the rate at which the RBI lends money to the commercial banks for a short-term (max. 90 days). When the repo rate increases, borrowing from RBI becomes more expensive. If RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate similarly, if it wants to make it cheaper for banks to borrow Currency: Indian rupee (₹).

Retrieved on 26 December Get instant notifications from Economic Times Allow Not now. The banks use the reverse repo facility to deposit their short-term excess funds with the RBI and earn interest on it. Such institutions can settle their trades for securities held in SGL through a Delivery-versus-Payments DVP mechanism [or spot deals], which ensures movement of funds and securities simultaneously.

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Under the RBI’s new restructured liquidity framework, the term repo is named as Variable Rate Term Repo. It is called variable rate repo because the interest rate is varied depending upon the auction rate.

The minimum bid amount for the auction would be Rupees one crore and multiples thereof. The allotment would be in multiples of Rupees one crore. Term repo auctions would be conducted on Fridays between 2. In case Friday falls on a holiday, the auction would take place on the preceding working day at Mumbai.

There will be provision of pro-rata allotment should there be more than one successful bid at the cut-off rate. There will be no restriction on the maximum amount of bidding by individual bidders under term repo. All other terms and conditions as applicable to LAF operations will also be made applicable to term repo mutatis mutandis. These conditions will, however, be subject to review on a periodic basis. The first such term repo auction will be conducted on October 11, Friday for 7 days.

This hike is unlikely to push the short-term interest rate. A greater impact will be on long term interest rates. This means that banks will now have extra liquidity to lend to the customers. Therefore, while the long term rates have gone up the short term rates have actually eased after the policy.

However, if the global economic condition remains somewhat similar and if the crude oil price does not cool down significantly in the near future, the FD rates in India may rise marginally. So, the banks will not be in a huge rush to increase the fixed deposit rates. As the RBI stance has also been neutral so I think the banks will increase the FD rate maximum by 25 basis points in next 3 months.

Whenever the central bank raises the rates there is higher level of transmission of the hike in overall banking system as banks raise their interest rates both for lending and deposits, while the contrary may not be always true when the RBI cuts the rates. Hence, we may see higher transmission in the current scenario and interest rate of FDs with long term tenure may reach in the range of 7.

Predominantly, repos are undertaken on overnight basis, i. The consideration amount in the first leg of the repo transactions is the amount borrowed by the seller of the security.

Settlement of repo transactions happens along with the outright trades in government securities. In the first leg of the transaction, sale price of securities is usually based on the prevailing market price for outright deals. As the ownership of securities passes on from seller to buyer for the repo period, legally the coupon interest accrued for the period has to be passed on to the buyer.

Hence, in the second leg happening on the future date, the price will be structured based on the funds flow of interest and tax elements of funds exchanged.

When repo rate is higher than current yield, repurchase price will be adjusted upward signifying a capital loss. If the repo rate is lower than the current yield, then the repurchase price will be adjusted downward signifying a capital gain. If the repo rate and coupon are equal, then the repurchase price will be equal to the sale price of security. Repo is thus, a money market instrument combining elements of two different types of transactions viz. A repo is also called a ready forward transaction as it is a means of funding by selling a security held on a spot ready basis and repurchasing the same on a forward basis.

When the reverse repurchase transaction matures, the counterparty returns the security to the entity concerned and receives its cash along with a profit spread. One factor which encourages an organisation to enter into reverse repo is that it earns some extra income on its otherwise idle cash. Whether a transaction is a repo or a reverse repo is determined only in terms of who initiated the first leg of the transaction. In other words, a transaction is called a repo when viewed from the perspective of the supplier of the securities the party acquiring funds and a reverse repo when described from the point of view of the supplier of funds.

Repos are hybrid transactions since they combine features of both secured loans and outright purchase and sale transactions, but they do not fit cleanly into either of these classifications. The repo buyer's right to trade the securities during the term of the agreement, by contrast, represents a transfer of ownership that typically does not occur in collateralized lending arrangements.

Since repos are attached with a repurchase agreement it makes the repo instrument less risky as there is no doubt about the liquidity of the security given as collateral since the borrower himself is willing to buy back the security. Repo transactions have mostly replaced the non-collateralised borrowing call loans in the market. The aim of term repo is to help develop inter-bank money market, which in turn can set market based benchmarks for pricing of loans and deposits, and through that improve transmission of monetary policy.

Term repo auctions are conducted on e-kuber platform through electronic bidding as is done in the case of auctions under Open Market Operations OMO [5]. The total amount of liquidity injected through term repos is limited to 0. Banks would be required to place their bids with the term repo rate that they are willing to pay to RBI for the tenor of the repo expressed in percentage terms up to two decimal places. While the 14 day term repo of tenor would be conducted every reporting Friday, the 7 day term repo would be conducted on every non-reporting Friday.

In case the notified amount for the day term repo is not fully subscribed, a 7-day term repo would be conducted on the following Friday for the remaining un-subscribed amount.

In case of full subscription in the day term repo, there will be no 7 day term repo auction on the following Friday. The Urjit Patel Committee recommended that as the day term repo rate stabilizes, central bank liquidity should be increasingly provided at the day term repo rate and through the introduction of day, day and day variable rate auctioned term repos by further calibrating the availability of liquidity at the overnight repo rate as necessary. The objective should be to develop a spectrum of term repos of varying maturities with the day term repo as the anchor.

The committee felt that overnight repos under the LAF have effectively converted the discretionary liquidity facility into a standing facility that could be accessed as the first resort, and precludes the development of markets that price and hedge risk. Improved transmission of monetary policy thus becomes the prime objective for setting the day term repo rate as the operating target instead of the weighted average call money rates.

In its April Monetary Policy statement, RBI allowed substitution of securities in market repo transactions in order to facilitate development of the term money market. SLBM is a mechanism under which securities are temporarily transferred by one party the lender to another the borrower via an approved intermediary Clearing Corporations. While securities lending generally happens in many countries on the Over the Counter OTC negotiated platform, in India, securities lending is mandated to be on the stock exchange platform where automatic order matching is one.

A SLB trade involves transfer of securities for a fee lending Fees , for a pre-determined period from the lender to the borrower; the borrower is obliged to return them either on demand or at the end of the agreed term.

The SLBM has mainly been used for shorting securities in the cash market i. Gandhi had recommended introduction of tripartite repo in India to develop a term repo market. In this context, it has been decided to undertake a comprehensive review of collateralised money market segments, including introduction of tripartite repo, in consultation with market participants.

The review is scheduled to be published by RBI by September for wider feedback. Collateralized Borrowing and lending Obligations CBLO developed by Clearing Corporation of India Ltd CCIL is considered as a repo variant with the combined structure of held -in-custody and tripartite repo in which the contract can be traded, unlike other standard repo in which the security under repo can be traded but the contract cannot be unwound till the end of the contract.

CBLO is a money market instrument operated by the CCIL for the benefit of the entities who have either no access to the unsecured inter-bank call money market or have restricted access in terms of ceiling on call borrowing and lending transactions. CCIL matches the borrowing and lending orders submitted by the members and notifies them.

While the securities held as collateral are in custody of the CCIL, the beneficial interest of the lender on the securities is recognized through proper documentation. Here, the clearing corporation - CCIL - provides an anonymous order matching system for trading funds against the collaterals, which are immobilized at the service provider.

The repo markets operating in India can be broadly classified into two, based on the nature of securities used for repo transactions. It has got actually three different functional segments-. The operations of LAF are conducted by way of repos and reverse repos with RBI being the counter-party to all the transactions. It is conducted at a fixed time on a daily basis and on special occasions if liquidity situation warrants so. Also, an additional LAF repo is conducted on reporting Fridays.

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