Banks may be allowed to trade in interest futures

The Reserve Bank of India is considering a proposal to allow banks to trade in interest rate futures.

Thus far, banks were allowed to use the products to hedge. Interest rate futures, introduced a few months back, has failed to attract market interest barring few token deals done at its launch.

At a meeting on Tuesday, the RBI, Securities Exchange Board of India  took stock of the situation with market participants.

The objective was to sort out the structural and operational problems that had come in the way of the development of interest rate futures.

One of the ideas floated by market participants was inclusion of banks along with primary dealers as traders in interest rate futures.

According to market sources, the proposal is under consideration as banks are only permitted to hedge their own positions now.

Even if PDs are allowed to trade, they are few in number with limited capital and therefore face problems to create the market where they is hardly any seller.

Another issue that has plagued its market growth is the pricing of the instrument for which zero-coupon yield curve is to be adopted as a benchmark as per RBI guidelines. This is in contrast to the market practice which takes the market yield-to-maturity as the benchmark for pricing of underlying instruments.

This in turn leaves a great anomaly for pricing of interest rate futures when the underlying government securities take YTM as the basis for calculation.

Sebi is understood to be working on solving the issue so as to remove the operational aberration, market sources said.

Another issue discussed was the stunted growth in retailing of government securities. Sources said earlier there was active market making done for retail players with daily two-way quotes available.

Now demand for gilts has picked up but market players have ceased to offer two-way quotes. RBI urged market players to play their bit in promoting retailing of gilts.