Posts tagged ‘CBLO Arbitrage’

CBLO (Collateralised Borrowing and Lending Obligation)

Introduction

CBLO (Collateralized Borrowing and Lending Obligation) Introduction was announced in year 2002-03 by RBI. It a money market instrument similar to REPO. Now let’s try and understand why it was introduced. As we know Call money market is a market where cash for less than a year tenure is borrowed and lent without any collateral. Also Call money market is open to Banks and PDs only. Hence there was a need for short term market akin call money market to cater needs of Mutual Funds, Insurance, PFs,etc. Hence CBLO was then introduced whereby an organization with surplus fund can lend money to other organization with collateral in place. Hence borrowers lent relentlessly on account of secure transaction.

Membership

The membership of CBLO segment is extended to banks, primary dealers, mutual funds, financial institutions and insurance companies, who are members of the NDS. The borrowing members are required to open Constituent SGL (CSGL) Account with CCIL for depositing securities which are offered as collateral for the borrowing.

Types of CBLO

There are two types of markets in CBLO trading. They are CBLO Normal market and the CBLO Auction market. CBLO Normal market facilitates borrowing and lending by members on an online basis whereas CBLO Auction market facilitates borrowing and lending by members through submission of bids and offers in the system and its acceptance and announcement of cut off by Clearcorp. The minimum and multiple lot size for CBLO Normal market is Rs.5 lakhs. The minimum lot size for CBLO Auction market is Rs.50 lakhs and multiple lot size is Rs.5 lakhs. It also have order limit feature which varies for different individuals. Single Order Limit is the maximum amount that can be entered by a member per order and it is applicable to each member of the CBLO Segment.

Repo vs. CBLO

One question comes to anyone’s mind is that how is CBLO different from REPO. Well this is because:

  • It is tradable. Hence one can reverse the borrowing/lending position and repay before the term expires.
  • CBLO works on principle of novation. i.e. CCIL acts as counterparty to the transaction.
  • Screen based trading provides transparency and maintains anonymity of counter parties.

Increasing Volume

  • Liquidity is high with number of player in the market,
  • Trades are executed anonymously and
  • CBLO product is approved by RBI as money market instrument and the product is also approved by Insurance Regulatory authority. Ministry of Finance has also allowed investment in CBLOs by nongovernmental provident funds. The CBLO market commands wide acceptability among Indian money market participants which is reflected in its high volume.
  • CBLO volumes normally rise during advance tax outflow dates as corporates who park substantial fund in MFs pull out money to pay taxes.

Arbitrage Opportunity

Banks are the one who can enjoy arbitrage opportunity in this market. Well they had previously. As we know Banks park excess funds with RBI at Rev. Repo and borrow at Repo rate. Now in FYQ2 2009 Rev. Repo rates were at 3.25% whereas CBLO rates were hovering in the range of 2.5-3.25%. Hence banks with excess SLR use to borrow in CBLO market at 2.5-3% and lend the same to RBI at 3.25(the then prevailing Rev. Repo rate).

RBI has dictated the spread between Repo and Reverse repo at 1pc. Currently (as on 14th Dec 2012) Repo and Reverse Repo stands at 8% and 7% respectively. Hence the moment CBLO rates shifts above 8%, let’s say 8.15% then Banks would borrow at 8% (Repo Rate) from RBI and lend the same at 8.15% in CBLO market. In the same manner if CBLO rates fall below 7% let’s say 6.75% then banks would borrow from CBLO market at 6.75% and lend the same to RBI at 7 %( Rev. Repo Rate). So what we understand is CBLO rates will tend to range in between Repo and Rev. Repo rate of RBI, if not will lead to arbitrage. If CBLO exceeds/recedes RBI’s Repo /Rev. Repo then LAF volume may rise significantly.

Low Interest on Fridays

Previously borrowing from CBLO didn’t attracted any CRR requirement. In Mid 2009, RBI, to curb arbitrage opportunity asked banks to make up  CRR funds for borrowing in CBLO. Hence, to avoid excess deposition of CRR banks move to repo window on reporting Fridays squaring up outstanding position in CBLO.

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