Interest Rate Swap Deals Catch Market Fancy

The fledgling interest rate swap market, where participants exchange fixed interest rate commitments with floating interest rate or vice versa, has started growing by leaps and bounds.

Over the last one year, it has grown almost 10 fold. Money market dealers said the average daily trading volume in the market zoomed to around Rs 400 crore in November from daily averages of around Rs 40 crore just a year back. Foreign banks, private Indian banks, primary dealers and a handful of companies are active players in the swap market.

Growing activity in this market signifies that corporates are getting increasingly using this instrument to streamline their interest liabilities, depending on their expectation of where the interest rates are headed. Said the treasury head of a private bank: "The rise in volume reflects the maturity of the market. The product is gaining acceptance as a hedging mechanism against interest rate risks." Market participants are expecting the volume to touch Rs 1,000 crore in a year.

Along with the increase in volume in the secondary market, the rate of interest (fixed rate) in the swap market has also dipped considerably. The 3-month swap rate has dipped by more than 200 basis points to 7.19 per cent, while the six-month swap rate has dropped by around 300 basis points to 7.33 per cent today. The fall in the one-year swap rate was 350 basis point to 7.42 per cent.

Though the interest rate swap market has been operational since 1999, daily transactions are not reported in any stock exchange or to any regulator.

The principal component is not exchanged and hence there is no credit risk. The floating rate is generally pegged to the Mumbai inter-bank overnight rate (Mibor), though the parties to the deal are free to choose any other mutually acceptable benchmark rate. Nationalised banks like Bank of India and Bank of Baroda have done a couple of deals each, but are not active in daily trading.

The increase in volumes signifies the growing awareness of interest rate risks among different market players.

A dealer at a foreign bank said: "In 1999, when trading in the interest rate swap market first started, there were 6-7 participants. Now excluding corporates there are 14 active counterparties (banks and primary dealers) who are involved in daily trading in the swap market."

He also pointed out that the growing number of participants has reduced the bid-ask spread in the swap market to 4-5 basis points in recent times from the more than 10 basis points in deals done in November last year.