Written by Jainam Shah and Aneesha Tadi

Introduction

The overnight money market forms the backbone of modern financial systems, enabling institutions to manage liquidity seamlessly and maintain operational stability. In this dynamic space, benchmarks like the Mumbai Inter-Bank Offered Rate (“MIBOR”) have historically played a focal role in facilitating short-term inter-bank transactions. However, evolving market conditions and the increasing global shift towards secured and collateralized transactions have necessitated a re-evaluation of existing frameworks.

Recognizing these imperatives, the Reserve Bank of India (“RBI”) has proposed the introduction of the Secured Overnight Rupee Rate (“SORR”) to address the limitations of the Financial Benchmarks India Private Limited Overnight Mumbai Inter-Bank Outright Rate (“FBIL-Overnight MIBOR”) benchmark and align the Indian money market with international benchmarks. By leveraging transactions in the Triparty Repo (“TREPS”) and basket repo segments, SORR promises greater representativeness, cogency, and stability in benchmark rates.

This post delves into the nuances of the overnight money market, the existing MIBOR framework, and the rationale behind transitioning to SORR. Through a comparative analysis of market segments and computation methodologies, it highlights the advantages of SORR while outlining a phased transition strategy to minimize disruptions. The discourse emphasizes the importance of modernizing India’s financial benchmarks to enhance market resilience and foster long-term growth.

The Landscape of Overnight Money Markets

The money market serves as a marketplace for short-term financial instruments that function as near equivalents to cash, facilitating transactions in highly liquid investments. Within this market lies the overnight money market, a segment dedicated to short-term loans, typically spanning a single day, hence the term overnight. This market primarily serves banks and financial institutions, enabling them to manage their immediate liquidity needs by borrowing to cover shortfalls or lending surplus funds. This idea of overnight funding stems from the necessity for investors to maintain readily accessible, cash-like assets—to fulfil their reserve requirement, meet liquidity and payment obligations or preserve a risk-free reserve for mitigating financial uncertainties during periods of stress.

The onset of the next business day, when lenders and borrowers settle transactions from the previous night, marks a period of heightened activity in the overnight market. The interest rate associated with these short-term loans is referred to as the overnight rate. This rate exhibits an inverse relationship with the liquidity levels of banks, whereby an increase in the rate escalates the cost for banks to settle their accounts. Such changes have the potential to influence critical economic variables, including inflation and overall economic growth.

In India, the MIBOR was the overnight lending offered rate for Indian commercial banks, which was first introduced in 1998 by the National Stock Exchange (“NSE”). Initially, the rate was determined through a polling mechanism, which involved calculating a weighted average of the lending rates proposed by banks based on their anticipated borrowing costs. To address concerns over the potential manipulation and exaggeration of polled responses, a revised benchmark, FBIL-Overnight MIBOR, was introduced in 2015 by Financial Benchmarks India Private Limited (“FBIL”). This updated methodology derives the benchmark from actual interbank transactions, enhancing its credibility and precision. 

The FBIL-Overnight MIBOR is derived from the trade-weighted average of interbank call money transactions conducted on the Negotiated Dealing System – Call platform, operated by the Clearing Corporation of India Ltd, during the first hour of trading between 9:00 AM and 10:00 AM. The calculation is based on T+0 settlement transactions, requiring a minimum of ten trades with an aggregate transaction value of at least five billion Indian rupees. If these conditions are not fulfilled within the specified timeframe of one hour, the rate computation may be extended twice, with each extension lasting thirty minutes. Should the thresholds still remain unmet, FBIL will publish the rate from the preceding working day.

At first blush, the current benchmark system seems to have successfully mitigated the risk of manipulation in polled rates, making it significantly more robust than before. However, a closer analysis of uncollateralized call money market transactions, which serve as the foundation for MIBOR computation, highlights a critical concern. While the overall money market has expanded, the transaction volumes within the call money segment have largely remained stagnant. As a result, the benchmark rate is derived from a limited number and volume of transactions, thereby diminishing its reliability. This issue is further exacerbated by the fact that the rate is calculated exclusively from transactions executed during the first hour of the trading day, which narrows the data pool and compromises the benchmark’s reliability and accuracy.

Given similar limitations, the global money market saw a profound shift towards collateralized overnight markets since the global financial crisis. This shift has increased the volume of transactions and underscored the imperative for the RBI to reassess the current MIBOR framework. Recognizing this need, the RBI established a committee tasked with evaluating the framework, which subsequently recommended transitioning to SORR.

Analysing SORR – The Transition From Unsecured to Secured

The RBI has, thus, proposed the implementation of the Secured Overnight Rupee Rate, a new financial benchmark in the Indian Overnight Money Market designed to address the issues and rectify the limitations of the existing FBIL-Overnight MIBOR benchmark. The concept of SORR, as its name suggests, is rooted in secured and collateralized transactions, focusing on Triparty Repo (“TREPS”) and basket repo segments of the money market, in comparison to the call money market segment, which FBIL-Overnight MIBOR is based on.

The computation of SORR begins with identifying trades in the TREPS and basket repo segments of the collateralized money market instruments. The benchmark specifically excludes special repos since they are often driven by ‘short-covering’, which may lead to haphazard results. The computation methodology is designed to leverage a significant portion of the day’s trading activity. As per the research conducted by the committee, fifty per cent of TREPS trade and ninety per cent of basket repo transactions occur in the first three hours of the day. Hence, the SORR will be the volume-weighted average of the TREPS and basket repo transactions within the first three hours of the day.

To understand the need for SORR over MIBOR, we first need to understand the difference between TREPS, Basket Repo, and Call Money market segments of the money market.

	TREPS	Basket Repo	Call Money
Collateralized	Yes	Yes	No
Volume	High	Normal	Low
Volatility	Low	Low	High
Transparency	High	High	High
Participants	All financial institutions (including corporates and mutual funds).	All financial institutions (including corporates and mutual funds).	Only Banks and Primary dealers.

Moreover, the call money market represents only two per cent of the overall overnight money market transactions compared to TREPS and basket repo rate, which constitutes ninety-eight per cent of the overnight money market transactions. Thus, SORR is expected to be more representative of the actual market conditions rather than MIBOR, which further strengthens the benchmark’s resilience.

The proposed computation framework involves careful consideration of the trading environment to ensure accuracy and consistency. Transparency is an anchor to SORR’s design. All transactions included in the computation are executed on electronic trading platforms, where they are publicly displayed yet anonymized. Further, only taking secured transactions into account, the SORR ensures a lower degree of dispersion or volatility, perfectly aligning with the objective of introducing a new rate. Additionally, the volume-average methodology further strengthens SORR’s robustness, as it minimizes the influence of outliers and ensures that the benchmark rate reflects the broader market consensus.

The RBI has carefully considered the time frame for computing SORR, opting to replace the first-hour framework with the three-hour framework while not going overboard and introducing a full-day or ten-hour framework. This approach captures a significant portion of daily activity, thus making it better than the previous first-hour framework while not delaying benchmark publication. It balances the need for representativeness with operational efficiency, enabling SORR to be published at a time that supports its use in various financial applications.

In spite of these advantages, the FBIL, authorized by RBI, needs to make sure that the transition to SORR shall be a process of multiple phases to ensure minimum disruption to existing market practices. Instead of completely replacing the existing MIBOR with SORR, the RBI should adopt a strategy similar to the United States (“U.S.”) In the U.S., Secured Overnight Financing Rate (“SOFR”) was introduced alongside London Interbank Offer Rate (“LIBOR”) as a part of a phased approach under Alternative Reference Rates Committee (“ARRC’s”) Paced Transition Plan. Similarly, SORR should initially be introduced alongside MIBOR, which would allow the market participants to familiarize themselves with the new benchmark and gradually integrate it into their day-to-day operations.

Conclusion

The adoption of SORR would represent a significant advancement in India’s financial benchmark landscape. By adopting a benchmark based on secured and collateralized transactions, SORR addresses the limitations of MIBOR, positioning itself as a robust and reliable rate for the future. This strategic shift would align Indian benchmarks with international standards, thus fostering transparency, credibility and stability in the money markets while helping the Indian markets thrive in the competitive global financial landscape. However, a phased transition would be quintessential, ensuring minimal disruption, enabling market participants to adapt seamlessly to the new rate, and reinforcing confidence in the country’s overnight money markets.

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