Money Matters

Mumbai, Aug. 8: An RBI panel today recommended the physical settlement of interest rate futures contract.

The panel, whose recommendations on interest rate futures (IRF) contract were released by the Reserve Bank of India (RBI) today, also said that banks’ participation in IRF should be extended to their entire balance sheet.

Interest rate futures are futures contracts with interest-bearing instruments as underlying assets such as government bonds or treasury bills.

A futures contract is a contract traded on an exchange to buy or sell an underlying instrument at a fixed date in the future at a specified price.

The panel said, “The group recommends that banks be allowed to take trading positions in IRF subject to prudential regulations, including capital requirements.

“Further, the current approval for banks’ participation in IRF for hedging risk in their underlying investment portfolio of government securities classified under the ‘available for sale’ and ‘held for trading’ categories should be extended to the interest rate risk inherent in their entire balance sheet — including both on, and off, balance sheet items,” it said.

The panel said that a contract should be physically settled as futures markets based on cash settlement are subject to manipulation.

Headed by RBI executive director V. K. Sharma, the group’s first report was released on March 3 for public feedback and comments.

Interest rate futures are not new to India. It was introduced in June 2003 on the National Stock Exchange.

Three contracts were launched that included one based on a notional 10-year coupon bearing bond, another based on a notional 10-year zero coupon bond and a third contract based on a 91-day treasury bill. It, however, failed to capture the attention of participants, and no trading was subsequently reported.