The excess liquidity in the system is pulling down the overnight index swap (OIS) rate. Against 7 per cent at the beginning of the financial year, the rate is now roughly 6 per cent, which puts it below the bank rate (6.5 per cent) and the bid-ask spread has come down from 25 to 30 basis points to five basis points.
The OIS basically acts as a hedge against short-term spikes in overnight call rates. A fall in the OIS rate, even as the market is gaining in volume, suggests that interest rates may be headed downwards too. The derivative market is a window into the future as the rates here are expectations driven.
The OIS market has seen a slow but steady growth since its inception in the late nineties. From volumes running into a few crore rupees, the market is now clocking about Rs 200 crore a day. A derivative product, an OIS is a fixed-for-floating interest rate swap with a one week to two-year duration with the floating rate linked to a daily overnight reference rate.
It is an effective off-balance sheet hedge instrument that replicates a mismatched deposit position through either a short-term loan funded by an overnight deposit or an overnight loan funded by a short-term deposit. It allows financial entities like banks, development financial institutions, primary dealers and corporations to manage their liquidity requirements more effectively.
OIS was introduced in the Indian markets in 1998-99 at the height of the East Asian crisis when call money rates in India turned volatile. However, it was not until the Fixed Income Money Markets and Derivatives Association (FIMMDA) stepped in to formulate guidelines pertaining to OIS transactions a couple of years back that the OIS market really took off.
There are about 10 active players
