Mifor swaps worth $10 bn stuck

Close to $10 billion worth of Mifor (Mumbai implied forward rate) based swaps have been struck between corporates and banks. The inter-bank market volume is 10 times more "" around $100 billion.

The illiquidity or the inability to offload positions, following the Reserve Bank of India's ban on using Mifor as a benchmark for these swaps, is not a problem for these deals. These are done by two banks and they can extinguish the positions.

However, the deals struck between banks and corporates will soon be out-of-money. In other words, the monetary value of the deals will be negative as there are no quotes on Mifor-based swaps to reverse the positions, a dealer said.

The RBI is understood to have started discussing the issue with market participants.

Sources said the Indian central bank may give time to banks on this. The regulator is keen that the market uses a domestic benchmark for such swaps. "Discussions are on. The RBI is likely to give us time. However, it seems highly unlikely that the ban will be lifted," said a banker.

The RBI last week issued a circular directing the market players to use only domestic interest rate benchmark for hedging the interest rate risk by banks and corporates.

Earlier, banks used to offer derivative products with benchmarks of either Indian interest rate or Libor (London interbank offered rate).

With Libor going up sharply over one and a half years from 1.5 per cent to around 3-3.5 per cent, most of the corporate and banks who entered into such deals with other parties were caught unawares.

This is because they had hedged fixed rate high cost interest payoffs in soft interest rate regime with floating rate obligations pegged to Libor which was ruling below one per cent then.

However, with no quotes available now, the existing positions of the banks have also turned illiquid as there is no way to offload it. On the other hand, there is no point in holding the these products till maturity as they will lose their monetary value.

Significantly, most of the foreign banks used to hedge their positions back to back with their group entities abroad and thus did not show it as their own exposure in Indian books. With a ban on mifor swaps, the individual corporate limit of the banks will considerably squeeze down.

Crisil MarketWire adds: The RBI has offered no convincing explanation for its action, but it is likely that misuse of swaps by a handful of state-owned players prompted the ban. The Mifor swap was widely used to hedge currency positions. Quantos was used to hedge risk from exposure to overseas interest rates.

Quantos are rupee-denominated swaps pegged to the US Libor with a spread added to factor in sovereign and currency risk. Foreign banks were the major facilitators of counter-parties based abroad. There isn't much moaning about the end of Quantos. But the ban on Mifor swap is widely regretted and is seen as a retrograde step.

"Banning Mifor swaps is like throwing the baby out with the bath water," said a treasury official at a foreign bank.

Although Quantos was meant to hedge Indian entities against risk from interest rate movements overseas, it was misused to speculate by some, including a few government entities.

This was what invited the central bank's wrath, dealers said.