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The introduction of the Standing Deposit Facility (SDF) by the Reserve Bank of India has opened an arbitrage opportunity for banks.
They are borrowing from mutual funds via the Tri-party Repo Dealing System (TREPS) at around 3.50 per cent, on an average, and placing these funds with the RBI’s recently-introduced Standing Deposit Facility at 3.75 per cent. Banks are earning a clean spread of up to 25 basis points. TREPS and SDF are overnight liquidity management facilities.
The SDF has replaced Fixed Rate Reverse Repo as the floor of the liquidity adjustment facility (LAF) corridor. The SDF rate is 25 basis points below the repo rate (4 per cent). The Marginal Standing Facility (MSF), which is 25 basis points above the repo rate, is the ceiling of the LAF corridor. Before the introduction of SDF, banks arbitraged between TREPS (borrowing overnight) and the variable rate reverse repo (VRRR) auction (deploying funds with the RBI for 2-28 days).
Rollover risk
While the TREPS-VRRR arbitrage is still attractive as the spread is higher (up to 50 basis points), there could be a rollover risk for banks and the TREPS rate could go up.
The SDF has opened up an opportunity for banks to make the most of the interest rate differential between TREPS and SDF without any rollover risk.
RK Gurumurthy, Head-Treasury, Dhanlaxmi Bank, said: “There is certainly some arbitrage between TREPS and SDF. However, on reporting Fridays, banks may avoid as the borrowings may attract reserves. “The arbitrage is gradually thinning out. The weighted average TREPS rate is converging towards SDF lately and the arbitrage is barely 12-15 basis points,” he added.
On Thursday, the last traded rate on TREPS was 3.50 per cent and the weighted average rate was 3.68 per cent (3.57 per cent on Wednesday).
“The TREPS rate tends to soften towards the close of the trading session as mutual funds become a bit desperate to deploy their surplus. It is at this stage that banks do some bottom fishing,” said a senior public sector bank executive.
Besides interest rate differential, the different market trading hours are also working to the benefit of banks.
The overnight SDF, which has been introduced with effect from April 8, opens late — from 17:30 hours to 23:59 hours — while TREPS opens earlier — from 9 am to 2.30 pm — for ‘T+0’ (same day) settlement and 9 am to 5 pm for ‘T+1’ (next day) settlement.
Tri-party Repo contract
According to the RBI, “Tri-party Repo”means a repo contract where a third entity (apart from the borrower and the lender), called a Tri-party agent, acts as an intermediary between the two parties to the repo to facilitate services like collateral selection, payment and settlement, custody and management during the life of the transaction.
TREPS facilitates borrowing and lending of funds in the Tri-party Repo arrangement. Clearing Corporation of India Ltd (CCIL) is the Central Counterparty to all trades on TREPS and also performs the role and responsibilities of a Tri-party Repo Agent.
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