According to the meeting of Monetary Policy Committee on 5th August 2022, there is a hike in Repo Rate, Standing Deposit facility (SDF), Marginal Standing Facility (MSF) and Bank Rate. Currently, these rates are: • Repo Rate: 5.40% • SDF: 5.15%
• MSF: 5.65% • Bank Rate: 5.65% Currently, every commercial bank lends money to the borrowers based on External Benchmark Rate. Due to the changes in the Monetary Policy banks have to lend at a higher rate so that their margin i.e., Net Interest Margin isn’t affected. Housing Development Finance Corporation (HDFC Ltd). used certain derivative contracts to protect itself from the unforeseen interest rate risk and inflation risk. Primarily, HDFC Ltd. used to hedge itself using Overnight Index Swaps. HDFC Ltd. is India’s biggest Rupee Bond issuer this year. HDFC Ltd. entered into a Swap agreement known as total return swap to hedge interest rate risk on debt issuance. There is a switch in hedging tool as Reserve Bank of India (RBI) hiked the Repo Rate by 140 basis points to fight inflation. A Total Return Swap is a contract between two parties who exchange the return from a financial asset between them. In this agreement, one party makes payments based on a set rate while the other party makes payments based on the total return of an underlying asset. The underlying asset may be a bond, equity interest, or loan. Banks and other financial institutions use TRS agreements to manage risk exposure with minimal cash outlay. Under Total Return Swap agreement, banks bought easily tradable sovereign bonds on behalf of the Mumbai-based financier on their treasury books, and HDFC would pay the overnight MIBOR Rate and a spread to the lenders. This Swap agreement will make the liability and borrowings variable for HDFC and thus, it protects its lending margin. This will help policy rates to drop over the Duration of HDFC’s Bonds. Thank you.
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