ET Explainer: What does spike in US funding rates mean for India
Secured Overnight Financing Rate (SOFR), a global benchmark used to determine the price of US dollar-denominated loans and derivatives, jumped to an all-time high of 5.39%, Bloomberg reported. The development occurred due to turbulence in US funding markets and overnight repo transactions amid quantitative tightening by the Federal Reserve.
Meanwhile, ET reported on Wednesday that Indian companies are showing strong appetite for dollar loans, with firms set to borrow more than $25 billion abroad this year. What is the link between the SOFR and Indian corporate fundraising plans? What does the volatility in US funding markets mean for the American banking sector, which suffered a crisis in March 2023? How does the elevated cost of funds in the US percolate thousands of miles away to Indian corporates?
What is the repo market?
A repo, which stands for a repurchase agreement, is in many ways the fundamental building block of money markets the world around.
Essentially, the transaction involves financial market players like banks borrowing and lending money overnight using government securities as collateral. Banks typically need funds for a host of reasons, including mandatory reserve requirements.
Usually, the interest rate for overnight repos is closely linked with the central bank’s policy rate – for example the Reserve Bank’s repo rate in India.
What is derived from the repo market?
Benchmarks that are used to decide the pricing of a variety of credit products such as loans are derived from instruments belonging to the money markets. In the US, the SOFR is decided based on the prevailing rates in the repo market.
