Banks use RBI window to mitigate bond losses, book arbitrage gains

Borrowings rise for this reason, as also banks' need for short-term money

To mitigate losses in the bond market, banks are booking arbitrage gains by borrowing under the Reserve Bank of India (RBI's) Marginal Standing Facility (MSF) and investing in short-term debt instruments like commercial paper (CP) and treasury bills (T-bills).

Treasury executives and dealers said besides CP, many banks are in need of short-term money to repay deposits maturing in the near future. These banks are issuing certificates of deposit (CDs) where the coupon rate is at least 125 basis points (bps) above the MSF rate (10.25 per cent). This is also an avenue for making gains.

The borrowings under MSF have been rising since August. RBI data shows the daily average borrowing under MSF by banks has been a little over Rs 37,000 crore in August, while it was just Rs 4,800 crore in July 16-31. Banks borrowed Rs 69,585 crore from the MSF on Wednesday.

The MSF rate was increased from July 16 by 300 bps above the repo rate (at which RBI lends to banks) to 10.25 per cent, to tighten liquidity in the system and arrest the depreciating rupee. The repo rate is 7.25 per cent. Also, borrowing under RBI's Liquidity Adjustment Facility was capped.

“Borrowing at 10.25 per cent and using that money to invest in short-term money market instruments is a good arbitrage opportunity for banks. The CD, CP and T-bills rate are higher than the MSF rate, due to which banks are borrowing more from the MSF window,” said a treasury official of a public sector bank.

While it (MSF money) is indeed an opportunity to make profit from interest rate differentials, there are mark-to-market (revaluing assets at current values) risks on this. A treasury head of a foreign bank said, “Some MSF money is deployed in T-Bills (including auction) which provides gains. But it is not a free ride. In case RBI decides to jack up the MSF rate further, to say 12 per cent, then it would hit the investments.”

On Thursday, private sector lender IndusInd Bank raised about Rs 100 crore by issuing three-month CDs at 11.93 per cent. Even in the secondary market, the yield of a three-month CD is 11.66 per cent, while CP yields of the same maturity tenure are trading at 12.40 per cent. The 91-day T-bill yield is 11.14 per cent.

“Borrowings under MSF will rise further, as by mid-September, short-term rates will harden by 25-50 bps from current levels,” said another treasury official of a mid-sized public sector bank.

September 15 is the final date for payment of the first instalment of corporate advance tax. During such times, liquidity dries further in the system. RBI has already tightened liquidity to arrest the depreciating rupee. Though it had announced a partial relaxation on tight money earlier this month, liquidity in the system did not improve significantly. This has even resulted in bond yields rising, due to which the treasury portfolio of banks have been bleeding. The yield on the 10-year benchmark government bond 7.16 per cent 2023 was 7.44 per cent at the start of this quarter and is now near nine per cent. During this quarter, the yield has even breached nine per cent.

As the rupee has failed to strengthen much against the dollar, the Street does not expect RBI to ease the liquidity further in the mid-quarter review of monetary policy on September 18.

What is MSF?

The Marginal Standing Facility is a liquidity window (run by RBI) for banks to borrow money used to meet liquidity shortfall. RBI lends money at higher rates, indicating banks should use it with care. However, the frequency of banks tapping the window has gone up after RBI put severe restrictions on use of the normal Liquidity Adjustment Facility.