Q. What is/are the RBI Guideline(s) for the development of Internet Rate Swaps?

Q2- 16 July 2017.png

Answer: D.  All of the above

An Interest Rate Swap (IRS) is a financial contract between two parties exchanging or swapping a stream of interest payments for a ‘notional principal’ amount on multiple occasions during a specified period. Such contracts generally involve an exchange of a ‘fixed to floating’ or ‘floating to floating’ rates of interest. Accordingly, on each payment date – that occurs during the swap period – cash payments based on fixed/ floating and floating rates, are made by the parties to one another.

The basic purpose of IRS is to hedge the interest rate risk of constituents and enable them to structure the asset/liability profile best suited to their respective cash flows.

IRS was introduced in India in 1999.

IRS is an Over-the-counter (OTC) derivatives. OTC is a contract that are traded directly between two eligible parties, with or without the use of an intermediary
and without going through an exchange.

Banks have been allowed to use the IRS not only for hedging but also for trading (market making) purpose – which provision has boosted the treasury activity.

The payments in interest rate swaps are based upon the “INR-MIFOR (Mumbai Inter-Bank Forward Offered Rate )” Floating Rate Option. 

RBI had earlier restricted benchmarks only to domestic markets – where only O/N MIBOR was widely used. Upon a representation from banks, RBI allowed MIFOR as a benchmark for interest rate swaps, but later restricted the use of MIFOR only for inter-bank dealings. MIFOR combines LIBOR and forward premium, and is based on active forex market dealings.

International Swaps and Derivatives Association (ISDA) agreement is the standard document that is commonly used to govern over-the-counter derivatives transactions including IRS.  

Banks enter into International Swaps and Derivative Association (ISDA) Master Agreement for derivative transactions (excluding Forward exchange contracts) with other bank or retail / individual customer. 

RBI has permitted banks under ISDA Agreement, to opt for dual jurisdiction, i.e. under Indian as well as common law jurisdiction. This provision is important for global banks to engage with Indian banks.

Learn more:

  1. Draft comprehensive guidelines on derivatives
  2. Interest Rate Swap: How it Works
  3. Essay on the Derivative Products | India | Banks | Treasury Management
  5. Mumbai Interbank Forward Offer Rate (MIFOR)
  6. Implementation Group on OTC Derivatives Market Reforms
  7. Comprehensive guidelines on derivatives
  8. ISDA Master Agreement
  9. Forward Rate Agreements/ Interest Rate Swaps

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