CBLO and its impact on other Money Market Segments

Golaka C Nath & R Natarajan*

Abstract

Collateralized Borrowing and Lending Obligations, more popularly known as CBLO, hasbeen taking the center stage in financial markets in recent months. CBLO has been ainnovative product that provides tremendous flexibility to the user which a Repo does notprovide. During the initial period of its launching, the volume in CBLO market wasnegligible as it was a new product. Any new product takes time to integrate withcomparable products in the market. However as the time progressed, market participantsrealized the utility of the product and the restrictions imposed in call market for non-bankparticipants helped this market to grow. The CBLO, an infant in the financial world,stands on its own in this market, and the statistics display a calibrated integration ofCBLO market with other markets due to its advantages like CRR exemption, SLR statusfor the securities remaining unencumbered in the gilt accounts of the bank maintainedwith the CCIL under the Constituents' Subsidiary General Ledger (CSGL) facility, lowerrisk weight etc.

The statistical results presented in the paper have shown that introduction of CBLO is asignificant event in Indian financial market and it has a clear relationship with otherforms of the short term market. It has absorbed the liquidity mismatch arisen out of callmarket restrictions imposed by RBI.

* Shri Nath is Advisor, Eco. Research & Surveillance Dept. CCIL and Shri Natarajan is Manager, CBLOSettlement, CCIL, Mumbai.

22

Introduction:

Collateralized Borrowing and Lending Obligations, more popularly known as CBLO, has

been taking the center stage in financial markets in recent months. The innovative

product developed by CCIL facilitates anonymous order matching system for efficient

price discovery. It has taken a huge leap forward since its launch on Jan 20, 2003. Initial

low volumes in the segment is a thing of the past and now it clocks about Rs.30000

million per day with record volume of Rs.45470 million on September 14, 2004. The

product is revolutionary in nature as it provided much needed flexibility to trade in a

Repo type of contract with guaranteed settlement. CBLOs have been designed not only to

provide an additional short term market for liquidity but also to provide an alternative to

market participants who have been moving out of call market due to restrictions by RBI.

There are 70 entities that include banks, primary dealers, mutual funds, insurance

companies, financial institutions and co-operative banks that have been regularly trading

in the product. CBLO is also likely to take care of the needs of corporates in managing

their short term liquidity.

CBLO has been attracting market participants in recent months as restrictions have been

progressively introduced in the overnight call market. Effective from June 26, 2004, the

exposure to call market by non-bank entities has been pared down to 45% of their

average call market lending in the year 2000-01. Prudential limits were imposed on

borrowing/lending by banks and primary dealers in the call money market. With the RBI

moving closer to its ultimate goal of making the call market a pure inter bank market with

only exception being PDs, it would be imperative for market participants to move to

other alternative markets for managing their short term liquidity. The aftermath of call

market restrictions is also prominent in Repo market wherein the average daily volume

has surged from Rs.28000millions to Rs.48000millions during this period. However, the

CBLO, as a product has an edge over the Repo as it overcomes the restrictions in the

traditional Repo. Unlike the Repo, the CBLO allows an exit route for the borrowers and

lenders during the contract period.

33

The present article tries to study the impact of CBLO market on other comparable

markets like call market and Repo markets. Chart-1 gives the business growth of CBLO

segment of CCIL since its inception.

Business Grow th in CBLO segment (January 03 to July 04)

0.00

2000.00

4000.00

6000.00

8000.00

10000.00

12000.00

14000.00

16000.00

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CBLO

Data

The study covers the period from January 20, 2003 to July 31, 2004. For the period, we

have used the weekly volume data (Saturday to Friday) for CBLO, Call, Repo and LAF

markets. During the period, the LAF was modified by RBI (first 1-day Repo to 7-day and

14-day Repo in April 04 and reintroducing 1-day Repo). We have seen significant

increase in LAF window and on a daily basis about Rs.400000millions are deposited by

banks with RBI earning the guaranteed Repo rate on such deposits. Chart-2 gives the

volumes movement of various market segments during the period of our study.

Chart-2 Weekly Cumulative Volume

44

Weekly Cummulative Volume (January 03 to July 04)

0.0050000.00

100000.00150000.00200000.00250000.00300000.00350000.00400000.00450000.00500000.00

24-01

-03

24-02

-03

24-03

-03

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-03

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-04

Date

Rs.

in C

rore

sLAF

Call

Repo

CBLO

It is observed from the graph that call market weekly volume which remained over

Rs.600,000million till October 2003 has started tapering down slowly while CBLO and

Repo volumes have increased. Repo volumes have been surging steadily throughout the

study period indicating that a sizeable share of the reduction in call volume has spilled

over to Repo market. The CBLO market has witnessed heightened activity from January

2004 after the non-bank entities, especially the mutual funds, joined the segment. As

shown in the Chart-3, the CBLO market has achieved about 40% to 50% of the Repo

volumes in recent months, and the share is expected to increase with the participation of

all the market participants.

Chart-3 CBLO Repo Volume and Spread

55

CBLO_Repo Volume_Spread

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

Jan-0

3

Feb-0

3

Mar-0

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3

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3Ju

l-03

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me

(Rs.

in C

rore

s)

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

Spre

ad (%

)

CBLOREPOSpread

Chart-3 indicates the spread between CBLO and Repo rates during the initial months of

CBLO launching was above the neutral level but has been hovering around the zero level

in recent months. Logically the spread should be close to zero as both the market are

collateralized though CBLO provides more flexibility and hence rates in CBLO segment

should be lower than that of the Repo market. However, from January 2004, the spread

between the two markets has narrowed down signifying the fast integration of CBLO

market with other money market instruments.

It is observed from Chart-2 that RBI s Liquidity Adjustment Facility (LAF) which

peaked during the last week of July 2003 declined gradually till November 2003 and

thereafter reversed the position in a big way touching Rs.4,500,000 million during June

2004. The extension of tenor of the LAF to seven days from March 29, 2004 has not

deterred participants from parking funds in the window. LAF insulates the banks against

any southward interest rate risk when liquidity is high in the system thereby preventing

effective price discovery in the market and also shuts the door for the emergence short

term yield curve.

66

Methodology

The aim of the present paper is to study the impact of CBLO on other segments like Call,

Repo and LAF. The paper tries to find the relationship among various segments of the

market in terms of their trading volumes. We have used the weekly trading volumes as

well as their weekly changes to understand the relationship.

We have used all the log values of 4 variables as dependent as well as independent

variables to run the regressions. We have used the following equations to run the

regression analysis:

ebbba ++++= 332211 *** XXXY

where Y can be log values of either CBLO or LAF or REPO or CALL weekly volumes

and depending on the sequence X1, X2 and X3 would be LAF, REPO, CALL or CBLO

respectively.

We have made an event study to see if the introduction of this new product has any

impact in the overnight call or not. For this we have used a dummy variable that would

take the value of 1 after the introduction of CBLO and 0 before its introduction. For

this we have used the following equation where Call Volumes of week t is a function of

Call volumes of week t-1:

egba +++= - ttt DUMMYCallCall ** )1(

Results

We have studied the correlation of the segments and find that the correlations of these

market segments are significant at 1% level indicating strong relationship among these

markets. However, we have found that LAF is negatively correlated with Call, Call is

negatively correlated with all three segments and Repo is negatively correlated with Call

while CBLO is negatively correlated with Call. Table-1 gives the correlation results:

77

Table-1: Correlation of LAF, Call, Repo & CBLO Segments LAF Call Repo CBLO

LAF 1.00000 -0.50923 0.43622 0.70022 (

88

Now we move to study the robustness of the relationships using the regression analysis.

i. Effect of LAF on others: We found that weekly LAF volume has a negative

relationship with weekly call and Repo and positive relationship with CBLO

volumes through we find the p-values for CBLO and Repo being significant at

1% level of significance.

ii. Effect of Call on others: We found that weekly call volumes have a negative

relationship with LAF and CBLO while it has a positive relationship with

Repo though relationship is not found to be significant with LAF and Repo at

conventional levels. The relationship with CBLO was found to be significant

at 1% level.

iii. Effect of Repo on others: We found that weekly Repo volumes have a

negative relationship with LAF but positive relationship with Call and CBLO

though the relationship was found to be significant with CBLO and LAF at

1% level.

iv. Effect of CBLO on others: We found that CBLO has a negative relationship

with Call while maintaining a positive relationship with Repo and LAF. We

found the relationship of CBLO with all three market segments to be

significant at 1% level. For robustness check, we took the weekly changes in

all volumes of all four segments and run the regression. We find that changes

in CBLO weekly volumes has a significant relationship with changes in

weekly Call market volumes at 1% level.Table-3: Regression Results

Variable: LAFIndependent Variables Coefficients t Stat P-value

Call -0.01268 -0.04 0.9665Repo -0.70581 -2.96 0.0041

CBLO 0.58194 6.36 0.0001Variable: Call

LAF -0.00184 -0.04 0.9665Repo 0.09949 1.05 0.2990

CBLO -0.16742 -4.34 0.0001Variable: Repo

Call 0.14256 1.05 0.2990LAF -0.14659 -2.96 0.0041

CBLO 0.34091 10.13 0.0001Variable: CBLO

Call -1.18554 -4.34 0.0001Repo 1.68467 10.13 0.0001LAF 0.59727 6.36 0.0001

99

It is observed from the above results that trading volume in the call market has inverse

relationship with CBLO volumes as indicated by the negative co-efficient and

significance levels. The results point out the fact the call market restrictions have resulted

in moving business from call to other markets like CBLO and Repo. It also points out the

fact that the liquidity generated in the system by the call market restrictions and also by

the fresh inflows in the system has contributed to the development of all these markets.

Money Market Rate Movements

Market efficiency tells us that interest rate in related markets must be very close to each

other. However, LAF rate is a rigid rate at 4.5% while other market rates like Repo, Call

and CBLO depend on demand and supply conditions and the market participants

arbitrage capabilities. To understand the linkage dynamics of Call, Repo and CBLO rates,

we have taken all deals of respective markets for the month of August 2004 (25 days) and

arrived at their weighted average rates. The data reveals very high and significant

correlation between all three rates indicating high level of convergence. The average call

market rate has been found to be higher than Repo and CBLO indicating risk premium

for uncollateralized market. Table-4 gives us the summary statistics and Table 5 gives the

correlation of the above 3 market interest rates:

Table-4: Summary Statistics of Repo, Call & CBLO Rates

Variables N Mean Std. Dev Minimum MaximumRepo Rate 25 4.16019 0.25623 3.76058 4.88179Call Rate 25 4.32555 0.20116 3.95343 4.99758CBLO Rate 25 4.18352 0.33353 3.36000 4.94000

Table-5: Correlation of Repo, Call and CBLO Rates

Repo Rate Call Rate CBLO Rate

Repo Rate 1.00000 0.87419 0.91313 (

10

10

The Chart-4 gives the movement of all 3 rates during August 2004. As can be seen from

the chart, all rates have moved in tandem though most of the time, CBLO has a tendency

to reach lower levels vis--vis Repo or Call rates.

Chart-4: Money Market Rates Movement (August 2004)

Money Market Rates Movement (August 2004)

3.00

3.50

4.00

4.50

5.00

02-0

8-04

04-0

8-04

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Date

Rat

e (%

)

RepoRATE CallRATE CBLORATE

Conclusions:

CBLO has been a innovative product that provides tremendous flexibility to the user

which a Repo does not provide. During the initial period of its launching, the volume in

CBLO market was negligible as it was a new product. Any new product takes time to

integrate with comparable products in the market. However as the time progressed,

market participants realized the utility of the product and the restrictions imposed in call

market for non-bank participants helped this market to grow. The CBLO segment has

reached a trading volume of Rs.45470millions on September 14, 2004 indicating its

utility to market participants. Today it has fully integrated to the short term market

structure. The CBLO, an infant in the financial world, stands on its own in this market,

and the statistics display a calibrated integration of CBLO market with other markets due

to its advantages like CRR exemption, SLR status for the securities remaining

unencumbered in the gilt accounts of the bank maintained with the CCIL under the

11

11

Constituents' Subsidiary General Ledger (CSGL) facility, lower risk weight etc. The

wider usage of the instrument is expected to receive impetus from the establishment of

real time connectivity between the Public Debt Office (PDO) of the Reserve Bank and

CCIL and value-free transfer of securities between market participants and CCIL. RBI, in

its Credit Policy, has announced automatic value free transfer of securities through NDS

for the CBLO Segment.

The statistical results presented in the paper have shown that introduction of CBLO is a

significant event in Indian financial market and it has a clear relationship with other

forms of the short term market. It has absorbed the liquidity mismatch arisen out of call

market restrictions imposed by RBI.

Data Source: CCIL, RBI publications

12

12

Annexure-1: Overnight Call market Weekly Volumes

DateCall Volume (Rs. incrores Date

Call Volume (Rs. incrores

04-Jan-02 66738.245 17-Apr-03 18192.2211-Jan-02 85212.9 25-Apr-03 55619.1518-Jan-02 108993.83 02-May-03 33550.9625-Jan-02 95522.435 09-May-03 63842.4601-Feb-02 199394.69 14-May-03 39963.3608-Feb-02 106853.33 23-May-03 61481.8015-Feb-02 108389.065 30-May-03 63814.9922-Feb-02 97592.855 06-Jun-03 72403.1301-Mar-02 184080.53 13-Jun-03 76279.3808-Mar-02 102591.745 20-Jun-03 75700.9115-Mar-02 79612.74 27-Jun-03 57207.1122-Mar-02 109391.045 04-Jul-03 55771.8728-Mar-02 92085.285 11-Jul-03 54457.2405-Apr-02 105092.765 18-Jul-03 57133.6912-Apr-02 133996.15 25-Jul-03 61263.1519-Apr-02 227509.71 01-Aug-03 52176.7526-Apr-02 107718.055 08-Aug-03 51790.51

03-May-02 97121.155 14-Aug-03 54706.7510-May-02 142290.39 22-Aug-03 69813.5317-May-02 109063.835 29-Aug-03 74170.6324-May-02 120977.855 05-Sep-03 53685.3431-May-02 217979.89 12-Sep-03 70301.2007-Jun-02 101617.51 19-Sep-03 75999.9414-Jun-02 93729.905 26-Sep-03 76392.1921-Jun-02 94778.8 03-Oct-03 45745.7328-Jun-02 80907.16 10-Oct-03 71456.3005-Jul-02 189131.42 17-Oct-03 71257.6912-Jul-02 97394.59 24-Oct-03 72304.8819-Jul-02 107308.125 31-Oct-03 55126.0726-Jul-02 100954.57 07-Nov-03 57845.61

02-Aug-02 84045.37 14-Nov-03 49432.4609-Aug-02 109374.505 21-Nov-03 46665.3216-Aug-02 89783.095 28-Nov-03 30412.7123-Aug-02 96566.555 05-Dec-03 41668.1930-Aug-02 109596.3 12-Dec-03 47913.9806-Sep-02 97301.295 19-Dec-03 50799.2513-Sep-02 86393.935 26-Dec-03 39870.2720-Sep-02 104999.845 02-Jan-04 51507.1927-Sep-02 89885.06 09-Jan-04 51856.0504-Oct-02 59358.005 16-Jan-04 47855.9311-Oct-02 106281.52 23-Jan-04 49856.3218-Oct-02 76800.16 30-Jan-04 33599.4225-Oct-02 95921.33 06-Feb-04 32272.5801-Nov-02 99311.2 13-Feb-04 32738.5708-Nov-02 93843.755 20-Feb-04 25871.3715-Nov-02 92609.115 27-Feb-04 29161.90

13

13

22-Nov-02 65531.83 05-Mar-04 26706.0229-Nov-02 64981.915 12-Mar-04 32977.6106-Dec-02 65745.74 19-Mar-04 44818.0513-Dec-02 135120.625 26-Mar-04 44483.4220-Dec-02 87634.055 02-Apr-04 15019.6327-Dec-02 62449.745 08-Apr-04 23838.1403-Jan-03 82397.355 16-Apr-04 26846.7210-Jan-03 77374.88 23-Apr-04 31605.0617-Jan-03 78188.755 30-Apr-04 23692.9224-Jan-03 72200.05 07-May-04 25867.3431-Jan-03 70821.79 14-May-04 28788.5507-Feb-03 69021.47 21-May-04 32453.2814-Feb-03 52435.21 28-May-04 27544.3121-Feb-03 67870.10 04-Jun-04 31064.7928-Feb-03 67566.64 11-Jun-04 23275.7607-Mar-03 70806.64 18-Jun-04 32517.6313-Mar-03 67318.35 25-Jun-04 37588.4321-Mar-03 67698.72 02-Jul-04 27266.9728-Mar-03 76404.70 09-Jul-04 33934.3804-Apr-03 50021.21 16-Jul-04 36812.9810-Apr-03 54849.79 23-Jul-04 31157.60

14

14

Annexure - 2: Weekly Cumulative Volumes in LAF, CALL, REPO & CBLODate LAF Call Repo CBLO

24-Jan-03 14660.00 72200.05 6532.26 35.0031-Jan-03 11740.00 70821.79 8881.38 32.5007-Feb-03 34045.00 69021.47 9483.71 96.0014-Feb-03 8044.00 52435.21 6561.33 107.0021-Feb-03 36470.00 67870.10 7290.78 56.0028-Feb-03 2670.00 67566.64 15106.21 72.0007-Mar-03 31030.00 70806.64 12361.65 61.5013-Mar-03 2810.00 67318.35 11885.06 165.0021-Mar-03 13360.00 67698.72 9317.89 76.5028-Mar-03 17203.22 76404.70 14060.71 110.7004-Apr-03 66605.00 50021.21 2337.04 77.5010-Apr-03 110994.00 54849.79 6592.40 98.0017-Apr-03 43743.00 18192.22 3429.90 40.0025-Apr-03 175125.00 55619.15 8606.50 162.80

02-May-03 124020.00 33550.96 6032.32 138.2509-May-03 138820.00 63842.46 7016.68 115.7014-May-03 50665.00 39963.36 3781.33 72.3023-May-03 129576.00 61481.80 3762.96 89.0030-May-03 172160.00 63814.99 6621.16 100.0006-Jun-03 152895.00 72403.13 7639.00 97.4513-Jun-03 97818.00 76279.38 7074.59 47.7020-Jun-03 118270.00 75700.91 6691.69 51.0027-Jun-03 150163.00 57207.11 8507.28 77.5004-Jul-03 149535.00 55771.87 7624.53 174.0011-Jul-03 224080.00 54457.24 12405.05 279.4018-Jul-03 216785.00 57133.69 10068.89 266.0025-Jul-03 222005.00 61263.15 8462.08 204.20

01-Aug-03 238900.00 52176.75 5280.41 251.0008-Aug-03 248735.00 51790.51 9592.22 460.7014-Aug-03 158200.00 54706.75 8918.13 463.4022-Aug-03 184640.00 69813.53 8784.50 240.2529-Aug-03 163130.00 74170.63 11363.33 527.0005-Sep-03 210635.00 53685.34 12980.10 601.0012-Sep-03 164440.00 70301.20 9463.27 627.6519-Sep-03 167295.00 75999.94 8435.17 320.7526-Sep-03 105974.00 76392.19 12067.63 1000.2503-Oct-03 108790.00 45745.73 8685.03 117.0010-Oct-03 108815.00 71456.30 9559.44 328.0017-Oct-03 70270.00 71257.69 11613.90 355.7524-Oct-03 48406.00 72304.88 15856.62 359.2031-Oct-03 25800.00 55126.07 21438.96 210.6007-Nov-03 95305.00 57845.61 16576.16 701.5014-Nov-03 85805.00 49432.46 13324.04 637.6021-Nov-03 108445.00 46665.32 20252.62 193.2028-Nov-03 114920.00 30412.71 14447.17 211.20

15

15

05-Dec-03 179965.00 41668.19 15466.27 920.0012-Dec-03 166565.00 47913.98 14021.17 879.9019-Dec-03 148205.00 50799.25 11762.44 439.2026-Dec-03 122960.00 39870.27 11069.13 593.3002-Jan-04 188575.00 51507.19 16346.17 363.7509-Jan-04 230680.00 51856.05 19128.53 1346.6516-Jan-04 184825.00 47855.93 16753.53 1330.6523-Jan-04 158645.00 49856.32 17752.83 2612.4530-Jan-04 154430.00 33599.42 12020.56 1613.2506-Feb-04 189520.00 32272.58 10632.49 3057.2513-Feb-04 217055.00 32738.57 15031.08 3900.2520-Feb-04 186475.00 25871.37 13836.00 3598.8527-Feb-04 240340.00 29161.90 11684.48 3816.2005-Mar-04 216790.00 26706.02 15119.06 4998.1512-Mar-04 283090.00 32977.61 14832.07 5754.8019-Mar-04 273775.00 44818.05 15472.45 5198.4526-Mar-04 293915.00 44483.42 17397.81 7115.2002-Apr-04 214815.00 15019.63 26383.97 3856.1008-Apr-04 266880.00 23838.14 33501.72 5569.4016-Apr-04 314775.00 26846.72 33156.79 4002.4023-Apr-04 407220.00 31605.06 38030.75 9077.6530-Apr-04 305825.00 23692.92 30562.85 7961.05

07-May-04 315760.00 25867.34 27255.40 7665.8514-May-04 443880.00 28788.55 40361.99 11269.2021-May-04 439845.00 32453.28 31880.74 13163.3028-May-04 452540.00 27544.31 31487.30 11390.6004-Jun-04 411990.00 31064.79 31759.94 12026.8511-Jun-04 363565.00 23275.76 43691.51 11868.6018-Jun-04 361920.00 32517.63 35808.37 12000.6025-Jun-04 367875.00 37588.43 35663.69 13293.7002-Jul-04 382720.00 27266.97 15505.25 10347.4009-Jul-04 393355.00 33934.38 21991.00 12590.1016-Jul-04 350960.00 36812.98 27335.11 13754.4023-Jul-04 309725.00 31157.60 27186.60 13921.2530-Jul-04 356505.00 32333.73 28956.22 12861.95

Note: all volumes in Rs. Crores